Despite announcing strong earnings, Suzhou Hengmingda Electronic Technology Co., Ltd.'s (SZSE:002947) stock was sluggish. We think that the market might be paying attention to some underlying factors that they find to be concerning.

Examining Cashflow Against Suzhou Hengmingda Electronic Technology's Earnings

As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. 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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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.

Suzhou Hengmingda Electronic Technology has an accrual ratio of 0.20 for the year to December 2023. Unfortunately, that means its free cash flow fell significantly short of its reported profits. In fact, it had free cash flow of CN¥51m in the last year, which was a lot less than its statutory profit of CN¥281.4m. Notably, Suzhou Hengmingda Electronic Technology had negative free cash flow last year, so the CN¥51m it produced this year was a welcome improvement.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Suzhou Hengmingda Electronic Technology.

Our Take On Suzhou Hengmingda Electronic Technology's Profit Performance

Suzhou Hengmingda Electronic Technology didn't convert much of its profit to free cash flow in the last year, which some investors may consider rather suboptimal. Because of this, we think that it may be that Suzhou Hengmingda Electronic Technology's statutory profits are better than its underlying earnings power. But the good news is that its EPS growth over the last three years has been very impressive. 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. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. For example, we've found that Suzhou Hengmingda Electronic Technology has 2 warning signs (1 is potentially serious!) 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 Suzhou Hengmingda Electronic Technology'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.