Shareholders appeared unconcerned with CM Energy Tech Co., Ltd.'s (HKG:206) lackluster earnings report last week. We did some digging, and we believe the earnings are stronger than they seem.

A Closer Look At CM Energy Tech'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. 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 December 2023, CM Energy Tech had an accrual ratio of -0.36. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. In fact, it had free cash flow of US$54m in the last year, which was a lot more than its statutory profit of US$9.50m. CM Energy Tech's free cash flow improved over the last year, which is generally good to see.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of CM Energy Tech.

Our Take On CM Energy Tech's Profit Performance

Happily for shareholders, CM Energy Tech produced plenty of free cash flow to back up its statutory profit numbers. Based on this observation, we consider it possible that CM Energy Tech's statutory profit actually understates its earnings potential! Unfortunately, though, its earnings per share actually fell back over 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. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. You'd be interested to know, that we found 2 warning signs for CM Energy Tech and you'll want to know about these bad boys.

This note has only looked at a single factor that sheds light on the nature of CM Energy Tech'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. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying.

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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.