Brilliance Technology Co., Ltd.'s (SZSE:300542) stock showed strength after its weak earnings report. While shareholders may be willing to overlook soft profit numbers, we believe that they should also be taking into account some other factors which may be cause for concern.

Check out our latest analysis for Brilliance Technology

A Closer Look At Brilliance Technology'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. To get the accrual ratio we first subtract FCF from profit for a period, and then divide that number by the average operating assets for the period. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

For the year to March 2022, Brilliance Technology had an accrual ratio of 0.26. Unfortunately, that means its free cash flow fell significantly short of its reported profits. Even though it reported a profit of CN¥65.4m, a look at free cash flow indicates it actually burnt through CN¥75m in the last year. It's worth noting that Brilliance Technology generated positive FCF of CN¥169m a year ago, so at least they've done it in the past. The good news for shareholders is that Brilliance Technology's accrual ratio was much better last year, so this year's poor reading might simply be a case of a short term mismatch between profit and FCF. Shareholders should look for improved cashflow relative to profit in the current year, if that is indeed the case.

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

Our Take On Brilliance Technology's Profit Performance

Brilliance Technology's accrual ratio for the last twelve months signifies cash conversion is less than ideal, which is a negative when it comes to our view of its earnings. Therefore, it seems possible to us that Brilliance Technology's true underlying earnings power is actually less than its statutory profit. But at least holders can take some solace from the 64% per annum growth in EPS for the last three. 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 Brilliance Technology, you'd also look into what risks it is currently facing. Our analysis shows 3 warning signs for Brilliance Technology (1 doesn't sit too well with us!) and we strongly recommend you look at them before investing.

This note has only looked at a single factor that sheds light on the nature of Brilliance Technology'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.