Huarong Chemical's (SZSE:301256) Anemic Earnings Might Be Worse Than You Think

The subdued market reaction suggests that Huarong Chemical Co., Ltd.'s (SZSE:301256) recent earnings didn't contain any surprises. However, we believe that investors should be aware of some underlying factors which may be of concern.

Check out our latest analysis for Huarong Chemical

Zooming In On Huarong 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. 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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

That means a negative accrual ratio is a good thing, because it shows that the company is bringing in more free cash flow than its profit would suggest. 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".

For the year to September 2024, Huarong Chemical had an accrual ratio of 0.35. 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. Even though it reported a profit of CN¥98.4m, a look at free cash flow indicates it actually burnt through CN¥63m in the last year. We also note that Huarong 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¥63m.

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

Our Take On Huarong Chemical's Profit Performance

As we discussed above, we think Huarong 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 Huarong Chemical's underlying earnings power is lower than its statutory profit. Sadly, its EPS was down over the last twelve months. 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. So while earnings quality is important, it's equally important to consider the risks facing Huarong Chemical at this point in time. For instance, we've identified 3 warning signs for Huarong Chemical (2 make us uncomfortable) you should be familiar with.

Today we've zoomed in on a single data point to better understand the nature of Huarong Chemical's profit. But there are plenty of other ways to inform your opinion of a company. 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. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks with high insider ownership.

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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.