Zhenjiang Dongfang Electric Heating TechnologyLtd's (SZSE:300217) Performance Raises Some Questions

Despite posting strong earnings, Zhenjiang Dongfang Electric Heating Technology Co.,Ltd's (SZSE:300217) stock didn't move much over the last week. We think that investors might be worried about the foundations the earnings are built on.

View our latest analysis for Zhenjiang Dongfang Electric Heating TechnologyLtd

Zooming In On Zhenjiang Dongfang Electric Heating TechnologyLtd's Earnings

Many investors haven't heard of the accrual ratio from cashflow, but it is actually a useful measure of how well a company's profit is backed up by free cash flow (FCF) during a given period. 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. This ratio tells us how much of a company's profit is not backed by free cashflow.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. That is not intended to imply we should worry about a positive accrual ratio, but it's worth noting where the accrual ratio is rather high. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

For the year to March 2024, Zhenjiang Dongfang Electric Heating TechnologyLtd had an accrual ratio of 0.40. Statistically speaking, that's a real negative for future earnings. To wit, the company did not generate one whit of free cashflow in that time. In the last twelve months it actually had negative free cash flow, with an outflow of CN¥231m despite its profit of CN¥661.8m, mentioned above. We saw that FCF was CN¥431m a year ago though, so Zhenjiang Dongfang Electric Heating TechnologyLtd has at least been able to generate positive FCF in the past. However, that's not all there is to consider. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio. The good news for shareholders is that Zhenjiang Dongfang Electric Heating TechnologyLtd's accrual ratio was much better last year, so this year's poor reading might simply be a case of a short term mismatch between profit and FCF. Shareholders should look for improved cashflow relative to profit in the current year, if that is indeed the case.

That might leave you wondering what analysts are forecasting in terms of future profitability. Luckily, you can click here to see an interactive graph depicting future profitability, based on their estimates.

The Impact Of Unusual Items On Profit

Given the accrual ratio, it's not overly surprising that Zhenjiang Dongfang Electric Heating TechnologyLtd's profit was boosted by unusual items worth CN¥296m in the last twelve months. While it's always nice to have higher profit, a large contribution from unusual items sometimes dampens our enthusiasm. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And, after all, that's exactly what the accounting terminology implies. We can see that Zhenjiang Dongfang Electric Heating TechnologyLtd's positive unusual items were quite significant relative to its profit in the year to March 2024. All else being equal, this would likely have the effect of making the statutory profit a poor guide to underlying earnings power.

Our Take On Zhenjiang Dongfang Electric Heating TechnologyLtd's Profit Performance

Summing up, Zhenjiang Dongfang Electric Heating TechnologyLtd received a nice boost to profit from unusual items, but could not match its paper profit with free cash flow. Considering all this we'd argue Zhenjiang Dongfang Electric Heating TechnologyLtd's profits probably give an overly generous impression of its sustainable level of profitability. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. Be aware that Zhenjiang Dongfang Electric Heating TechnologyLtd is showing 3 warning signs in our investment analysis and 2 of those shouldn't be ignored...

Our examination of Zhenjiang Dongfang Electric Heating TechnologyLtd has focussed on certain factors that can make its earnings look better than they are. And, on that basis, we are somewhat skeptical. 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. 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.