Solid Earnings May Not Tell The Whole Story For Zhejiang Shuangyuan Technology (SHSE:688623)

The recent earnings posted by Zhejiang Shuangyuan Technology Co., Ltd. (SHSE:688623) were solid, but the stock didn't move as much as we expected. However the statutory profit number doesn't tell the whole story, and we have found some factors which might be of concern to shareholders.

View our latest analysis for Zhejiang Shuangyuan Technology

A Closer Look At Zhejiang Shuangyuan Technology'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. 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. 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 March 2024, Zhejiang Shuangyuan Technology recorded an accrual ratio of 0.48. Statistically speaking, that's a real negative for future earnings. To wit, the company did not generate one whit of free cashflow in that time. Even though it reported a profit of CN¥131.8m, a look at free cash flow indicates it actually burnt through CN¥39m in the last year. We saw that FCF was CN¥56m a year ago though, so Zhejiang Shuangyuan Technology has at least been able to generate positive FCF in the past. One positive for Zhejiang Shuangyuan Technology 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.

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

Our Take On Zhejiang Shuangyuan Technology's Profit Performance

As we have made quite clear, we're a bit worried that Zhejiang Shuangyuan Technology didn't back up the last year's profit with free cashflow. As a result, we think it may well be the case that Zhejiang Shuangyuan Technology's underlying earnings power is lower than its statutory profit. The silver lining is that its EPS growth over the last year has been really wonderful, even if it's not a perfect measure. 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 Shuangyuan Technology at this point in time. For example, we've found that Zhejiang Shuangyuan Technology has 2 warning signs (1 shouldn't be ignored!) that deserve your attention before going any further with your analysis.

Today we've zoomed in on a single data point to better understand the nature of Zhejiang Shuangyuan Technology's profit. But there is always more to discover if you are capable of focussing your mind on minutiae. 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 that insiders are buying 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.