We Think That There Are Issues Underlying HUNAN RESUN's (SZSE:001218) Earnings

Last week's profit announcement from HUNAN RESUN Co., Ltd. (SZSE:001218) was underwhelming for investors, despite headline numbers being robust. We did some digging and found some worrying underlying problems.

View our latest analysis for HUNAN RESUN

Examining Cashflow Against HUNAN RESUN'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.

Therefore, it's actually considered a good thing when a company has a negative accrual ratio, but a bad thing if its accrual ratio is positive. 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 December 2023, HUNAN RESUN recorded an accrual ratio of 0.20. We can therefore deduce that its free cash flow fell well short of covering its statutory profit. In the last twelve months it actually had negative free cash flow, with an outflow of CN¥142m despite its profit of CN¥135.7m, mentioned above. It's worth noting that HUNAN RESUN generated positive FCF of CN¥150m a year ago, so at least they've done it in the past. One positive for HUNAN RESUN shareholders is that it's accrual ratio was significantly better last year, providing reason to believe that it may return to stronger cash conversion in the future. Shareholders should look for improved cashflow relative to profit in the current year, if that is indeed the case.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of HUNAN RESUN.

Our Take On HUNAN RESUN's Profit Performance

HUNAN RESUN didn't convert much of its profit to free cash flow in the last year, which some investors may consider rather suboptimal. Therefore, it seems possible to us that HUNAN RESUN's true underlying earnings power is actually less than its statutory profit. The good news is that, its earnings per share increased by 14% in the last year. Of course, we've only just scratched the surface when it comes to analysing its earnings; one could also consider margins, forecast growth, and return on investment, among other factors. If you'd like to know more about HUNAN RESUN as a business, it's important to be aware of any risks it's facing. For example, we've found that HUNAN RESUN has 4 warning signs (2 shouldn't be ignored!) that deserve your attention before going any further with your analysis.

Today we've zoomed in on a single data point to better understand the nature of HUNAN RESUN's profit. But there is always more to discover if you are capable of focussing your mind on minutiae. Some people consider a high return on equity to be a good sign of a quality business. 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 that insiders are buying to be useful.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.