Changzhou Zhongying Science & Technology (SZSE:300936) Shareholders Should Be Cautious Despite Solid Earnings

Shareholders didn't seem to be thrilled with Changzhou Zhongying Science & Technology Co., Ltd's (SZSE:300936) recent earnings report, despite healthy profit numbers. Our analysis has found some concerning factors which weaken the profit's foundation.

See our latest analysis for Changzhou Zhongying Science & Technology

A Closer Look At Changzhou Zhongying Science & Technology's Earnings

In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). 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. 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".

Changzhou Zhongying Science & Technology has an accrual ratio of 0.27 for the year to March 2024. We can therefore deduce that its free cash flow fell well short of covering its statutory profit. Indeed, in the last twelve months it reported free cash flow of CN¥26m, which is significantly less than its profit of CN¥147.0m. Given that Changzhou Zhongying Science & Technology had negative free cash flow in the prior corresponding period, the trailing twelve month resul of CN¥26m would seem to be a step in the right direction. However, that's not all there is to consider. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Changzhou Zhongying Science & Technology.

The Impact Of Unusual Items On Profit

The fact that the company had unusual items boosting profit by CN¥128m, in the last year, probably goes some way to explain why its accrual ratio was so weak. While we like to see profit increases, we tend to be a little more cautious when unusual items have made a big contribution. When we crunched the numbers on thousands of publicly listed companies, we found that a boost from unusual items in a given year is often not repeated the next year. Which is hardly surprising, given the name. We can see that Changzhou Zhongying Science & Technology's positive unusual items were quite significant relative to its profit in the year to March 2024. All else being equal, this would likely have the effect of making the statutory profit a poor guide to underlying earnings power.

Our Take On Changzhou Zhongying Science & Technology's Profit Performance

Changzhou Zhongying Science & Technology had a weak accrual ratio, but its profit did receive a boost from unusual items. Considering all this we'd argue Changzhou Zhongying Science & Technology's profits probably give an overly generous impression of its sustainable level of profitability. If you'd like to know more about Changzhou Zhongying Science & Technology as a business, it's important to be aware of any risks it's facing. For example, we've found that Changzhou Zhongying Science & Technology has 3 warning signs (1 is a bit concerning!) that deserve your attention before going any further with your analysis.

In this article we've looked at a number of factors that can impair the utility of profit numbers, and we've come away cautious. 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. 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.