Suzhou Hengmingda Electronic Technology's (SZSE:002947) Promising Earnings May Rest On Soft Foundations

Investors were disappointed with Suzhou Hengmingda Electronic Technology Co., Ltd.'s (SZSE:002947) earnings, despite the strong profit numbers. We did some digging and found some worrying underlying problems.

See our latest analysis for Suzhou Hengmingda Electronic Technology

Examining Cashflow Against Suzhou Hengmingda Electronic 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'.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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".

Suzhou Hengmingda Electronic Technology has an accrual ratio of 0.20 for the year to December 2023. We can therefore deduce that its free cash flow fell well short of covering its statutory profit. In fact, it had free cash flow of CN¥51m in the last year, which was a lot less than its statutory profit of CN¥281.4m. Given that Suzhou Hengmingda Electronic Technology had negative free cash flow in the prior corresponding period, the trailing twelve month resul of CN¥51m would seem to be a step in the right direction.

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

Our Take On Suzhou Hengmingda Electronic Technology's Profit Performance

Suzhou Hengmingda Electronic 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 Suzhou Hengmingda Electronic Technology's true underlying earnings power is actually less than its statutory profit. But on the bright side, its earnings per share have grown at an extremely impressive rate 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 Suzhou Hengmingda Electronic Technology as a business, it's important to be aware of any risks it's facing. For example, Suzhou Hengmingda Electronic Technology has 2 warning signs (and 1 which doesn't sit too well with us) we think you should know about.

Today we've zoomed in on a single data point to better understand the nature of Suzhou Hengmingda Electronic 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. 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.