Shanxi Tond Chemical's (SZSE:002360) Solid Earnings May Rest On Weak Foundations

The stock price didn't jump after Shanxi Tond Chemical Co., Ltd. (SZSE:002360) posted decent earnings last week. We did some digging and believe investors may be worried about some underlying factors in the report.

View our latest analysis for Shanxi Tond Chemical

Examining Cashflow Against Shanxi Tond Chemical'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.

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. 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 September 2024, Shanxi Tond Chemical had an accrual ratio of 0.50. As a general rule, that bodes poorly for future profitability. And indeed, during the period the company didn't produce any free cash flow whatsoever. Over the last year it actually had negative free cash flow of CN¥1.1b, in contrast to the aforementioned profit of CN¥327.2m. We also note that Shanxi Tond Chemical's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥1.1b.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Shanxi Tond Chemical.

Our Take On Shanxi Tond Chemical's Profit Performance

As we discussed above, we think Shanxi Tond Chemical'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 Shanxi Tond Chemical's underlying earnings power is lower than its statutory profit. But the good news is that its EPS growth over the last three years has been very impressive. At the end of the day, it's essential to consider more than just the factors above, if you want to understand the company properly. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. For example, Shanxi Tond Chemical has 3 warning signs (and 2 which are potentially serious) we think you should know about.

Today we've zoomed in on a single data point to better understand the nature of Shanxi Tond Chemical'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 with significant insider holdings 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.