The market seemed underwhelmed by last week's earnings announcement from Shandong Sunway Chemical Group Co., Ltd. (SZSE:002469) despite the healthy numbers. We did some digging, and we think that investors are missing some encouraging factors in the underlying numbers.

A Closer Look At Shandong Sunway Chemical Group'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. The ratio shows us how much a company's profit exceeds its FCF.

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 December 2023, Shandong Sunway Chemical Group had an accrual ratio of -0.13. That implies it has good cash conversion, and implies that its free cash flow solidly exceeded its profit last year. In fact, it had free cash flow of CN¥457m in the last year, which was a lot more than its statutory profit of CN¥282.2m. Shandong Sunway Chemical Group shareholders are no doubt pleased that free cash flow improved over the last twelve months.

That might leave you wondering what analysts are forecasting in terms of future profitability. Luckily, you can click here to see an interactive graph depicting future profitability, based on their estimates.

Our Take On Shandong Sunway Chemical Group's Profit Performance

As we discussed above, Shandong Sunway Chemical Group has perfectly satisfactory free cash flow relative to profit. Based on this observation, we consider it likely that Shandong Sunway Chemical Group's statutory profit actually understates its earnings potential! 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. So while earnings quality is important, it's equally important to consider the risks facing Shandong Sunway Chemical Group at this point in time. In terms of investment risks, we've identified 1 warning sign with Shandong Sunway Chemical Group, and understanding it should be part of your investment process.

Today we've zoomed in on a single data point to better understand the nature of Shandong Sunway Chemical Group'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.