Weak Statutory Earnings May Not Tell The Whole Story For Hangzhou Chuhuan Science & Technology (SZSE:001336)

A lackluster earnings announcement from Hangzhou Chuhuan Science & Technology Company Limited (SZSE:001336) last week didn't sink the stock price. However, we believe that investors should be aware of some underlying factors which may be of concern.

Check out our latest analysis for Hangzhou Chuhuan Science & Technology

Examining Cashflow Against Hangzhou Chuhuan Science & Technology's Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. The accrual ratio subtracts the FCF from the profit for a given period, and divides the result by the average operating assets of the company over that time. The ratio shows us how much a company's profit exceeds its FCF.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. While it's not a problem to have a positive accrual ratio, indicating a certain level of non-cash profits, a high accrual ratio is arguably a bad thing, because it indicates paper profits are not matched by cash flow. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

For the year to March 2024, Hangzhou Chuhuan Science & Technology had an accrual ratio of 0.20. We can therefore deduce that its free cash flow fell well short of covering its statutory profit. Even though it reported a profit of CN¥34.9m, a look at free cash flow indicates it actually burnt through CN¥64m in the last year. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of CN¥64m, this year, indicates high risk.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Hangzhou Chuhuan Science & Technology.

Our Take On Hangzhou Chuhuan Science & Technology's Profit Performance

Hangzhou Chuhuan Science & Technology's accrual ratio for the last twelve months signifies cash conversion is less than ideal, which is a negative when it comes to our view of its earnings. Therefore, it seems possible to us that Hangzhou Chuhuan Science & Technology's true underlying earnings power is actually less than its statutory profit. Sadly, its EPS was down over the last twelve months. At the end of the day, it's essential to consider more than just the factors above, if you want to understand the company properly. If you'd like to know more about Hangzhou Chuhuan Science & Technology as a business, it's important to be aware of any risks it's facing. Every company has risks, and we've spotted 3 warning signs for Hangzhou Chuhuan Science & Technology (of which 2 can't be ignored!) you should know about.

This note has only looked at a single factor that sheds light on the nature of Hangzhou Chuhuan Science & Technology's profit. But there are plenty of other ways to inform your opinion of a company. For example, many people consider a high return on equity as an indication of favorable business economics, while others like to 'follow the money' and search out stocks that insiders are buying. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.