We Think That There Are More Issues For Zhejiang Chengchang Technology (SZSE:001270) Than Just Sluggish Earnings

The subdued market reaction suggests that Zhejiang Chengchang Technology Co., Ltd.'s (SZSE:001270) recent earnings didn't contain any surprises. Our analysis suggests that along with soft profit numbers, investors should be aware of some other underlying weaknesses in the numbers.

Check out our latest analysis for Zhejiang Chengchang Technology

A Closer Look At Zhejiang Chengchang Technology'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. 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. 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".

Over the twelve months to December 2023, Zhejiang Chengchang Technology recorded an accrual ratio of 0.27. Unfortunately, that means its free cash flow fell significantly short of its reported profits. Even though it reported a profit of CN¥79.7m, a look at free cash flow indicates it actually burnt through CN¥131m in the last year. We also note that Zhejiang Chengchang Technology's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥131m.

That might leave you wondering what analysts are forecasting in terms of future profitability. Luckily, you can click here to see an interactive graph depicting future profitability, based on their estimates.

Our Take On Zhejiang Chengchang Technology's Profit Performance

Zhejiang Chengchang Technology didn't convert much of its profit to free cash flow in the last year, which some investors may consider rather suboptimal. Therefore, it seems possible to us that Zhejiang Chengchang Technology's true underlying earnings power is actually less than its statutory profit. But at least holders can take some solace from the 15% per annum growth in EPS for the last three. 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 Zhejiang Chengchang Technology at this point in time. Case in point: We've spotted 2 warning signs for Zhejiang Chengchang Technology you should be mindful of and 1 of these bad boys shouldn't be ignored.

This note has only looked at a single factor that sheds light on the nature of Zhejiang Chengchang Technology'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. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying.

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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.