Henan Jinma Energy Company Limited's (HKG:6885) robust recent earnings didn't do much to move the stock. We believe that shareholders have noticed some concerning factors beyond the statutory profit numbers.

See our latest analysis for Henan Jinma Energy

A Closer Look At Henan Jinma Energy'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. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. The ratio shows us how much a company's profit exceeds its FCF.

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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Henan Jinma Energy has an accrual ratio of 0.47 for the year to December 2021. As a general rule, that bodes poorly for future profitability. And indeed, during the period the company didn't produce any free cash flow whatsoever. Even though it reported a profit of CN¥486.4m, a look at free cash flow indicates it actually burnt through CN¥1.3b in the last year. We saw that FCF was CN¥247m a year ago though, so Henan Jinma Energy has at least been able to generate positive FCF in the past.

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

Our Take On Henan Jinma Energy's Profit Performance

As we have made quite clear, we're a bit worried that Henan Jinma Energy didn't back up the last year's profit with free cashflow. As a result, we think it may well be the case that Henan Jinma Energy's underlying earnings power is lower than its statutory profit. The good news is that its earnings per share increased slightly in the last year. Of course, we've only just scratched the surface when it comes to analysing its earnings; one could also consider margins, forecast growth, and return on investment, among other factors. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. To help with this, we've discovered 3 warning signs (2 are a bit unpleasant!) that you ought to be aware of before buying any shares in Henan Jinma Energy.

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