The subdued stock price reaction suggests that Zhejiang Asia-Pacific Mechanical & Electronic Co.,Ltd's (SZSE:002284) strong earnings didn't offer any surprises. Investors are probably missing some underlying factors which are encouraging for the future of the company.

Zooming In On Zhejiang Asia-Pacific Mechanical & ElectronicLtd's Earnings

In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). 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'.

That means a negative accrual ratio is a good thing, because it shows that the company is bringing in more free cash flow than its profit would suggest. While it's not a problem to have a positive accrual ratio, indicating a certain level of non-cash profits, a high accrual ratio is arguably a bad thing, because it indicates paper profits are not matched by cash flow. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Zhejiang Asia-Pacific Mechanical & ElectronicLtd has an accrual ratio of -0.24 for the year to December 2023. That indicates that its free cash flow quite significantly exceeded its statutory profit. In fact, it had free cash flow of CN¥526m in the last year, which was a lot more than its statutory profit of CN¥97.0m. Zhejiang Asia-Pacific Mechanical & ElectronicLtd's free cash flow improved over the last year, which is generally good to see.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Zhejiang Asia-Pacific Mechanical & ElectronicLtd.

Our Take On Zhejiang Asia-Pacific Mechanical & ElectronicLtd's Profit Performance

Happily for shareholders, Zhejiang Asia-Pacific Mechanical & ElectronicLtd produced plenty of free cash flow to back up its statutory profit numbers. Because of this, we think Zhejiang Asia-Pacific Mechanical & ElectronicLtd's underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! Better yet, its EPS are growing strongly, which is nice to see. 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. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. You'd be interested to know, that we found 1 warning sign for Zhejiang Asia-Pacific Mechanical & ElectronicLtd and you'll want to know about this.

This note has only looked at a single factor that sheds light on the nature of Zhejiang Asia-Pacific Mechanical & ElectronicLtd'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.