Kale Environmental Technology (Shanghai) Corporation's (SZSE:301070) recent weak earnings report didn't cause a big stock movement. Our analysis suggests that along with soft profit numbers, investors should be aware of some other underlying weaknesses in the numbers.

See our latest analysis for Kale Environmental Technology (Shanghai)

Zooming In On Kale Environmental Technology (Shanghai)'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). 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. This ratio tells us how much of a company's profit is not backed by free cashflow.

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

For the year to March 2022, Kale Environmental Technology (Shanghai) had an accrual ratio of 0.41. 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¥45.6m, a look at free cash flow indicates it actually burnt through CN¥63m in the last year. It's worth noting that Kale Environmental Technology (Shanghai) generated positive FCF of CN¥18m a year ago, so at least they've done it in the past.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Kale Environmental Technology (Shanghai).

Our Take On Kale Environmental Technology (Shanghai)'s Profit Performance

As we discussed above, we think Kale Environmental Technology (Shanghai)'s earnings were not supported by free cash flow, which might concern some investors. As a result, we think it may well be the case that Kale Environmental Technology (Shanghai)'s underlying earnings power is lower than its statutory profit. In further bad news, its earnings per share decreased in the 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. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. Be aware that Kale Environmental Technology (Shanghai) is showing 3 warning signs in our investment analysis and 1 of those is concerning...

Today we've zoomed in on a single data point to better understand the nature of Kale Environmental Technology (Shanghai)'s profit. But there is always more to discover if you are capable of focussing your mind on minutiae. Some people consider a high return on equity to be a good sign of a quality business. 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.