Solid Earnings May Not Tell The Whole Story For Wuhan DR Laser TechnologyLtd (SZSE:300776)

Wuhan DR Laser Technology Corp.,Ltd's (SZSE:300776 ) stock didn't jump after it announced some healthy earnings. We think that investors might be worried about some concerning underlying factors.

See our latest analysis for Wuhan DR Laser TechnologyLtd

Examining Cashflow Against Wuhan DR Laser TechnologyLtd'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. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. 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. While it's not a problem to have a positive accrual ratio, indicating a certain level of non-cash profits, a high accrual ratio is arguably a bad thing, because it indicates paper profits are not matched by cash flow. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Wuhan DR Laser TechnologyLtd has an accrual ratio of 0.46 for the year to June 2024. That means it didn't generate anywhere near enough free cash flow to match its profit. As a general rule, that bodes poorly for future profitability. To wit, it produced free cash flow of CN¥62m during the period, falling well short of its reported profit of CN¥523.1m. Wuhan DR Laser TechnologyLtd's free cash flow actually declined over the last year, but it may bounce back next year, since free cash flow is often more volatile than accounting profits. One positive for Wuhan DR Laser TechnologyLtd shareholders is that it's accrual ratio was significantly better last year, providing reason to believe that it may return to stronger cash conversion in the future. Shareholders should look for improved cashflow relative to profit in the current year, if that is indeed the case.

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 Wuhan DR Laser TechnologyLtd's Profit Performance

As we discussed above, we think Wuhan DR Laser TechnologyLtd'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 Wuhan DR Laser TechnologyLtd's underlying earnings power is lower than its statutory profit. Nonetheless, it's still worth noting that its earnings per share have grown at 33% over the last three years. 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. If you'd like to know more about Wuhan DR Laser TechnologyLtd as a business, it's important to be aware of any risks it's facing. For example, we've found that Wuhan DR Laser TechnologyLtd has 2 warning signs (1 doesn't sit too well with us!) that deserve your attention before going any further with your analysis.

This note has only looked at a single factor that sheds light on the nature of Wuhan DR Laser TechnologyLtd'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.