ZheJiang HuaSheng TechnologyLtd's (SHSE:605180) Profits Appear To Have Quality Issues

ZheJiang HuaSheng Technology Co.,Ltd's (SHSE:605180 ) stock didn't jump after it announced some healthy earnings. Our analysis showed that there are some concerning factors in the earnings that investors may be cautious of.

Check out our latest analysis for ZheJiang HuaSheng TechnologyLtd

Examining Cashflow Against ZheJiang HuaSheng TechnologyLtd'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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

For the year to September 2024, ZheJiang HuaSheng TechnologyLtd had an accrual ratio of 0.30. Unfortunately, that means its free cash flow was a lot less than its statutory profit, which makes us doubt the utility of profit as a guide. Over the last year it actually had negative free cash flow of CN¥129m, in contrast to the aforementioned profit of CN¥47.2m. We saw that FCF was CN¥55m a year ago though, so ZheJiang HuaSheng TechnologyLtd has at least been able to generate positive FCF in the past. The good news for shareholders is that ZheJiang HuaSheng 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. As a result, some shareholders may be looking for stronger cash conversion in the current year.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of ZheJiang HuaSheng TechnologyLtd.

Our Take On ZheJiang HuaSheng TechnologyLtd's Profit Performance

ZheJiang HuaSheng TechnologyLtd'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 ZheJiang HuaSheng TechnologyLtd's true underlying earnings power is actually less than its statutory profit. The good news is that, its earnings per share increased by 40% in the last year. 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 ZheJiang HuaSheng TechnologyLtd as a business, it's important to be aware of any risks it's facing. For example, we've found that ZheJiang HuaSheng TechnologyLtd has 3 warning signs (2 are a bit unpleasant!) that deserve your attention before going any further with your analysis.

This note has only looked at a single factor that sheds light on the nature of ZheJiang HuaSheng TechnologyLtd's profit. But there are plenty of other ways to inform your opinion of a company. 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 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.