The subdued market reaction suggests that Anhui Higasket Plastics Co.,Ltd.'s (SHSE:603150) recent earnings didn't contain any surprises. We think that investors are worried about some weaknesses underlying the earnings.

Zooming In On Anhui Higasket PlasticsLtd's Earnings

In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. The ratio shows us how much a company's profit exceeds its FCF.

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. 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, Anhui Higasket PlasticsLtd recorded an accrual ratio of 0.27. Unfortunately, that means its free cash flow fell significantly short of its reported profits. Over the last year it actually had negative free cash flow of CN¥268m, in contrast to the aforementioned profit of CN¥135.5m. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of CN¥268m, this year, indicates high risk.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Anhui Higasket PlasticsLtd.

Our Take On Anhui Higasket PlasticsLtd's Profit Performance

Anhui Higasket PlasticsLtd didn't convert much of its profit to free cash flow in the last year, which some investors may consider rather suboptimal. Therefore, it seems possible to us that Anhui Higasket PlasticsLtd's true underlying earnings power is actually less 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. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. Every company has risks, and we've spotted 3 warning signs for Anhui Higasket PlasticsLtd (of which 1 can't be ignored!) you should know about.

This note has only looked at a single factor that sheds light on the nature of Anhui Higasket PlasticsLtd's profit. But there are plenty of other ways to inform your opinion of a company. 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.