We Think Huadian Energy's (SHSE:600726) Healthy Earnings Might Be Conservative

Shareholders appeared to be happy with Huadian Energy Company Limited's (SHSE:600726) solid earnings report last week. According to our analysis of the report, the strong headline profit numbers are supported by strong earnings fundamentals.

Check out our latest analysis for Huadian Energy

Zooming In On Huadian Energy's Earnings

As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. 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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Huadian Energy has an accrual ratio of -0.11 for the year to March 2024. That indicates that its free cash flow was a fair bit more than its statutory profit. To wit, it produced free cash flow of CN¥2.1b during the period, dwarfing its reported profit of CN¥169.1m. Huadian Energy's free cash flow actually declined over the last year, which is disappointing, like non-biodegradable balloons.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Huadian Energy.

Our Take On Huadian Energy's Profit Performance

Huadian Energy's accrual ratio is solid, and indicates strong free cash flow, as we discussed, above. Because of this, we think Huadian Energy's earnings potential is at least as good as it seems, and maybe even better! And one can definitely find a positive in the fact that it made a profit this year, despite losing money last year. The goal of this article has been to assess how well we can rely on the statutory earnings to reflect the company's potential, but there is plenty more to consider. If you want to do dive deeper into Huadian Energy, you'd also look into what risks it is currently facing. In terms of investment risks, we've identified 1 warning sign with Huadian Energy, and understanding this should be part of your investment process.

Today we've zoomed in on a single data point to better understand the nature of Huadian Energy'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.