Last week's earnings announcement from Guangdong Hongming Intelligent Joint Stock Co., Ltd. (SZSE:301105) was disappointing to investors, with a sluggish profit figure. We did some analysis, and found that there are some reasons to be cautious about the headline numbers.

See our latest analysis for Guangdong Hongming Intelligent

A Closer Look At Guangdong Hongming Intelligent's Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. 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. 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Guangdong Hongming Intelligent has an accrual ratio of 0.35 for the year to December 2022. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, raising questions about how useful that profit figure really is. In the last twelve months it actually had negative free cash flow, with an outflow of CN¥80m despite its profit of CN¥39.4m, mentioned above. We also note that Guangdong Hongming Intelligent's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥80m.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Guangdong Hongming Intelligent.

Our Take On Guangdong Hongming Intelligent's Profit Performance

As we have made quite clear, we're a bit worried that Guangdong Hongming Intelligent didn't back up the last year's profit with free cashflow. For this reason, we think that Guangdong Hongming Intelligent's statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. Sadly, its EPS was down over the last twelve months. 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. In light of this, if you'd like to do more analysis on the company, it's vital to be informed of the risks involved. At Simply Wall St, we found 2 warning signs for Guangdong Hongming Intelligent and we think they deserve your attention.

This note has only looked at a single factor that sheds light on the nature of Guangdong Hongming Intelligent'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. 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.