The subdued market reaction suggests that Zhongtian Construction (Hunan) Group Limited's (HKG:2433) recent earnings didn't contain any surprises. We think that investors are worried about some weaknesses underlying the earnings.

View our latest analysis for Zhongtian Construction (Hunan) Group

Zooming In On Zhongtian Construction (Hunan) 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. 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. 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Zhongtian Construction (Hunan) Group has an accrual ratio of 0.32 for the year to June 2023. Unfortunately, that means its free cash flow was a lot less than its statutory profit, which makes us doubt the utility of profit as a guide. Even though it reported a profit of CN¥59.7m, a look at free cash flow indicates it actually burnt through CN¥71m in the last year. We saw that FCF was CN¥55m a year ago though, so Zhongtian Construction (Hunan) Group has at least been able to generate positive FCF in the past.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Zhongtian Construction (Hunan) Group.

Our Take On Zhongtian Construction (Hunan) Group's Profit Performance

As we discussed above, we think Zhongtian Construction (Hunan) Group'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 Zhongtian Construction (Hunan) Group's underlying earnings power is lower than its statutory profit. In further bad news, its earnings per share decreased in the last year. 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. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. For example, we've found that Zhongtian Construction (Hunan) Group has 3 warning signs (1 is a bit unpleasant!) that deserve your attention before going any further with your analysis.

This note has only looked at a single factor that sheds light on the nature of Zhongtian Construction (Hunan) Group'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.