Zhejiang Jingsheng Mechanical & Electrical Co., Ltd.'s (SZSE:300316) robust recent earnings didn't do much to move the stock. We think this is due to investors looking beyond the statutory profits and being concerned with what they see.

Zooming In On Zhejiang Jingsheng Mechanical & Electrical'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. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. This ratio tells us how much of a company's profit is not backed by free cashflow.

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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Over the twelve months to December 2023, Zhejiang Jingsheng Mechanical & Electrical recorded an accrual ratio of 0.35. 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. Indeed, in the last twelve months it reported free cash flow of CN¥613m, which is significantly less than its profit of CN¥4.56b. Notably, Zhejiang Jingsheng Mechanical & Electrical had negative free cash flow last year, so the CN¥613m it produced this year was a welcome improvement.

That might leave you wondering what analysts are forecasting in terms of future profitability. Luckily, you can click here to see an interactive graph depicting future profitability, based on their estimates.

Our Take On Zhejiang Jingsheng Mechanical & Electrical's Profit Performance

As we have made quite clear, we're a bit worried that Zhejiang Jingsheng Mechanical & Electrical didn't back up the last year's profit with free cashflow. As a result, we think it may well be the case that Zhejiang Jingsheng Mechanical & Electrical's underlying earnings power is lower than its statutory profit. But on the bright side, its earnings per share have grown at an extremely impressive rate over the last three years. 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. If you want to do dive deeper into Zhejiang Jingsheng Mechanical & Electrical, you'd also look into what risks it is currently facing. To help with this, we've discovered 2 warning signs (1 shouldn't be ignored!) that you ought to be aware of before buying any shares in Zhejiang Jingsheng Mechanical & Electrical.

This note has only looked at a single factor that sheds light on the nature of Zhejiang Jingsheng Mechanical & Electrical'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.