Zhejiang Zhengguang Industrial's (SZSE:301092) Problems Go Beyond Weak Profit

A lackluster earnings announcement from Zhejiang Zhengguang Industrial Co., Ltd. (SZSE:301092) last week didn't sink the stock price. We think that investors are worried about some weaknesses underlying the earnings.

Check out our latest analysis for Zhejiang Zhengguang Industrial

Examining Cashflow Against Zhejiang Zhengguang Industrial's Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. 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. 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. 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 June 2024, Zhejiang Zhengguang Industrial recorded an accrual ratio of 0.47. As a general rule, that bodes poorly for future profitability. To wit, the company did not generate one whit of free cashflow in that time. Even though it reported a profit of CN¥110.0m, a look at free cash flow indicates it actually burnt through CN¥184m in the last year. We also note that Zhejiang Zhengguang Industrial's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥184m.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Zhejiang Zhengguang Industrial.

Our Take On Zhejiang Zhengguang Industrial's Profit Performance

As we have made quite clear, we're a bit worried that Zhejiang Zhengguang Industrial didn't back up the last year's profit with free cashflow. For this reason, we think that Zhejiang Zhengguang Industrial's statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. Sadly, its EPS was down over the last twelve months. 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. So while earnings quality is important, it's equally important to consider the risks facing Zhejiang Zhengguang Industrial at this point in time. Be aware that Zhejiang Zhengguang Industrial is showing 2 warning signs in our investment analysis and 1 of those shouldn't be ignored...

Today we've zoomed in on a single data point to better understand the nature of Zhejiang Zhengguang Industrial's profit. 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. 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.