Additional Considerations Required While Assessing Shenzhen Jdd Tech New Material's (SZSE:301538) Strong Earnings

Despite announcing strong earnings, Shenzhen Jdd Tech New Material Co., Ltd's (SZSE:301538) stock was sluggish. We think that the market might be paying attention to some underlying factors that they find to be concerning.

See our latest analysis for Shenzhen Jdd Tech New Material

Examining Cashflow Against Shenzhen Jdd Tech New Material'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. The ratio shows us how much a company's profit exceeds its FCF.

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. 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Shenzhen Jdd Tech New Material has an accrual ratio of 0.34 for the year to June 2024. 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¥37m, in contrast to the aforementioned profit of CN¥169.0m. We saw that FCF was CN¥17m a year ago though, so Shenzhen Jdd Tech New Material has at least been able to generate positive FCF in the past.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Shenzhen Jdd Tech New Material.

Our Take On Shenzhen Jdd Tech New Material's Profit Performance

As we have made quite clear, we're a bit worried that Shenzhen Jdd Tech New Material didn't back up the last year's profit with free cashflow. For this reason, we think that Shenzhen Jdd Tech New Material's statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. But the good news is that its EPS growth over the last three years has been very impressive. 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. So while earnings quality is important, it's equally important to consider the risks facing Shenzhen Jdd Tech New Material at this point in time. In terms of investment risks, we've identified 2 warning signs with Shenzhen Jdd Tech New Material, and understanding them should be part of your investment process.

Today we've zoomed in on a single data point to better understand the nature of Shenzhen Jdd Tech New Material'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.