Soft earnings didn't appear to concern Cangzhou Dahua Co., Ltd.'s (SHSE:600230) shareholders over the last week. We did some digging, and we believe the earnings are stronger than they seem.

Zooming In On Cangzhou Dahua's Earnings

Many investors haven't heard of the accrual ratio from cashflow, but it is actually a useful measure of how well a company's profit is backed up by free cash flow (FCF) during a given period. The accrual ratio subtracts the FCF from the profit for a given period, and divides the result by the average operating assets of the company over that time. 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

For the year to March 2024, Cangzhou Dahua had an accrual ratio of -0.14. That indicates that its free cash flow quite significantly exceeded its statutory profit. In fact, it had free cash flow of CN¥852m in the last year, which was a lot more than its statutory profit of CN¥139.0m. Cangzhou Dahua shareholders are no doubt pleased that free cash flow improved over the last twelve months.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Cangzhou Dahua.

Our Take On Cangzhou Dahua's Profit Performance

As we discussed above, Cangzhou Dahua has perfectly satisfactory free cash flow relative to profit. Because of this, we think Cangzhou Dahua's earnings potential is at least as good as it seems, and maybe even better! Unfortunately, though, its earnings per share actually fell back over 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. If you'd like to know more about Cangzhou Dahua as a business, it's important to be aware of any risks it's facing. For example, we've discovered 2 warning signs that you should run your eye over to get a better picture of Cangzhou Dahua.

Today we've zoomed in on a single data point to better understand the nature of Cangzhou Dahua'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. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.