Wuhan Tianyuan Environmental ProtectionLTD's (SZSE:301127) Solid Earnings May Rest On Weak Foundations

The stock price didn't jump after Wuhan Tianyuan Environmental Protection Co.,LTD (SZSE:301127) posted decent earnings last week. We think that investors might be worried about some concerning underlying factors.

View our latest analysis for Wuhan Tianyuan Environmental ProtectionLTD

A Closer Look At Wuhan Tianyuan Environmental ProtectionLTD's Earnings

As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. To get the accrual ratio we first subtract FCF from profit for a period, and then divide that number by the average operating assets for the period. 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 having an accrual ratio above zero is of little concern, we do think it's worth noting when a company has a relatively high accrual ratio. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Over the twelve months to June 2024, Wuhan Tianyuan Environmental ProtectionLTD recorded an accrual ratio of 0.58. As a general rule, that bodes poorly for future profitability. To wit, the company did not generate one whit of free cashflow in that time. Even though it reported a profit of CN¥321.3m, a look at free cash flow indicates it actually burnt through CN¥1.1b 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¥1.1b, 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 Wuhan Tianyuan Environmental ProtectionLTD.

Our Take On Wuhan Tianyuan Environmental ProtectionLTD's Profit Performance

As we discussed above, we think Wuhan Tianyuan Environmental ProtectionLTD's earnings were not supported by free cash flow, which might concern some investors. As a result, we think it may well be the case that Wuhan Tianyuan Environmental ProtectionLTD's underlying earnings power is lower than its statutory profit. But on the bright side, its earnings per share have grown at an extremely impressive rate over the last three years. The goal of this article has been to assess how well we can rely on the statutory earnings to reflect the company's potential, but there is plenty more to consider. If you'd like to know more about Wuhan Tianyuan Environmental ProtectionLTD as a business, it's important to be aware of any risks it's facing. For example, Wuhan Tianyuan Environmental ProtectionLTD has 2 warning signs (and 1 which shouldn't be ignored) we think you should know about.

Today we've zoomed in on a single data point to better understand the nature of Wuhan Tianyuan Environmental ProtectionLTD's profit. But there is always more to discover if you are capable of focussing your mind on minutiae. 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. While it might take a little research on your behalf, you may find this free collection of companies boasting high return on equity, or this list of stocks with significant insider holdings to be useful.

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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.