China Treasures New Materials Group's (HKG:2439) Shareholders Have More To Worry About Than Only Soft Earnings

China Treasures New Materials Group Ltd.'s (HKG:2439) recent weak earnings report didn't cause a big stock movement. We think that investors are worried about some weaknesses underlying the earnings.

See our latest analysis for China Treasures New Materials Group

Zooming In On China Treasures New Materials Group'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. This ratio tells us how much of a company's profit is not backed by free cashflow.

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. 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

China Treasures New Materials Group has an accrual ratio of 0.21 for the year to June 2023. Unfortunately, that means its free cash flow fell significantly short of its reported profits. To wit, it produced free cash flow of CN¥33m during the period, falling well short of its reported profit of CN¥62.9m. China Treasures New Materials Group'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.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of China Treasures New Materials Group.

Our Take On China Treasures New Materials Group's Profit Performance

China Treasures New Materials Group didn't convert much of its profit to free cash flow in the last year, which some investors may consider rather suboptimal. Because of this, we think that it may be that China Treasures New Materials Group's statutory profits are better than its underlying earnings power. Sadly, its EPS was down over the last twelve months. 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'd like to know more about China Treasures New Materials Group as a business, it's important to be aware of any risks it's facing. You'd be interested to know, that we found 2 warning signs for China Treasures New Materials Group and you'll want to know about them.

Today we've zoomed in on a single data point to better understand the nature of China Treasures New Materials Group'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 that insiders are buying.

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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.