ZheJiang HuaSheng TechnologyLtd's (SHSE:605180) Sluggish Earnings Might Be Just The Beginning Of Its Problems

Despite ZheJiang HuaSheng Technology Co.,Ltd's (SHSE:605180) most recent earnings report having soft headline numbers, its stock has had a positive performance. We looked at the details, and we think that investors may be responding to some encouraging factors.

Check out our latest analysis for ZheJiang HuaSheng TechnologyLtd

A Closer Look At ZheJiang HuaSheng 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. 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 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".

ZheJiang HuaSheng TechnologyLtd has an accrual ratio of 0.25 for the year to March 2024. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, which is hardly a good thing. Even though it reported a profit of CN¥36.0m, a look at free cash flow indicates it actually burnt through CN¥113m in the last year. It's worth noting that ZheJiang HuaSheng TechnologyLtd generated positive FCF of CN¥150m a year ago, so at least they've done it in the past. Having said that, there is more to the story. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio. One positive for ZheJiang HuaSheng TechnologyLtd 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. 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.

How Do Unusual Items Influence Profit?

ZheJiang HuaSheng TechnologyLtd's profit suffered from unusual items, which reduced profit by CN¥3.6m in the last twelve months. If this was a non-cash charge, it would have made the accrual ratio better, if cashflow had stayed strong, so it's not great to see in combination with an uninspiring accrual ratio. While deductions due to unusual items are disappointing in the first instance, there is a silver lining. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And that's hardly a surprise given these line items are considered unusual. If ZheJiang HuaSheng TechnologyLtd doesn't see those unusual expenses repeat, then all else being equal we'd expect its profit to increase over the coming year.

Our Take On ZheJiang HuaSheng TechnologyLtd's Profit Performance

In conclusion, ZheJiang HuaSheng TechnologyLtd's accrual ratio suggests that its statutory earnings are not backed by cash flow, even though unusual items weighed on profit. Having considered these factors, we don't think ZheJiang HuaSheng TechnologyLtd's statutory profits give an overly harsh view of the business. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. To help with this, we've discovered 4 warning signs (3 are potentially serious!) that you ought to be aware of before buying any shares in ZheJiang HuaSheng TechnologyLtd.

Our examination of ZheJiang HuaSheng TechnologyLtd has focussed on certain factors that can make its earnings look better than they are. 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.

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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.