China ITS (Holdings) Co., Ltd.'s (HKG:1900) recent earnings report didn't offer any surprises, with the shares unchanged over the last week. We did some digging, and we think that investors are missing some encouraging factors in the underlying numbers.

See our latest analysis for China ITS (Holdings)

Examining Cashflow Against China ITS (Holdings)'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. 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. 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 June 2022, China ITS (Holdings) had an accrual ratio of -0.15. Therefore, its statutory earnings were very significantly less than its free cashflow. In fact, it had free cash flow of CN¥338m in the last year, which was a lot more than its statutory profit of CN¥38.9m. China ITS (Holdings)'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 China ITS (Holdings).

Our Take On China ITS (Holdings)'s Profit Performance

As we discussed above, China ITS (Holdings) has perfectly satisfactory free cash flow relative to profit. Based on this observation, we consider it likely that China ITS (Holdings)'s statutory profit actually understates its earnings potential! 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'd like to know more about China ITS (Holdings) as a business, it's important to be aware of any risks it's facing. While conducting our analysis, we found that China ITS (Holdings) has 1 warning sign and it would be unwise to ignore this.

This note has only looked at a single factor that sheds light on the nature of China ITS (Holdings)'s profit. But there is always more to discover if you are capable of focussing your mind on minutiae. 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.