Following the solid earnings report from Jiusheng Electric Co., LTD (SZSE:301082), the market responded by bidding up the stock price. While the profit numbers were good, our analysis has found some concerning factors that shareholders should be aware of.

View our latest analysis for Jiusheng Electric

Examining Cashflow Against Jiusheng Electric'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. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. 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. 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 2021, Jiusheng Electric had an accrual ratio of 0.67. As a general rule, that bodes poorly for future profitability. To wit, the company did not generate one whit of free cashflow in that time. Even though it reported a profit of CN¥87.9m, a look at free cash flow indicates it actually burnt through CN¥457m in the last year. It's worth noting that Jiusheng Electric generated positive FCF of CN¥19m 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 Jiusheng Electric.

Our Take On Jiusheng Electric's Profit Performance

As we have made quite clear, we're a bit worried that Jiusheng Electric didn't back up the last year's profit with free cashflow. As a result, we think it may well be the case that Jiusheng Electric's underlying earnings power is lower than its statutory profit. Nonetheless, it's still worth noting that its earnings per share have grown at 29% over the last three years. Of course, we've only just scratched the surface when it comes to analysing its earnings; one could also consider margins, forecast growth, and return on investment, among other factors. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. When we did our research, we found 3 warning signs for Jiusheng Electric (1 is concerning!) that we believe deserve your full attention.

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