Shareholders appeared unconcerned with People.cn CO., LTD's (SHSE:603000) lackluster earnings report last week. We did some digging, and we believe the earnings are stronger than they seem.

Zooming In On People.cn's Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. 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. 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.

People.cn has an accrual ratio of -0.11 for the year to March 2024. Therefore, its statutory earnings were quite a lot less than its free cashflow. In fact, it had free cash flow of CN¥402m in the last year, which was a lot more than its statutory profit of CN¥285.7m. People.cn 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 People.cn.

Our Take On People.cn's Profit Performance

People.cn's accrual ratio is solid, and indicates strong free cash flow, as we discussed, above. Because of this, we think People.cn's earnings potential is at least as good as it seems, and maybe even better! On the other hand, its EPS actually shrunk in the last twelve months. Of course, we've only just scratched the surface when it comes to analysing its earnings; one could also consider margins, forecast growth, and return on investment, among other factors. If you want to do dive deeper into People.cn, you'd also look into what risks it is currently facing. When we did our research, we found 2 warning signs for People.cn (1 can't be ignored!) that we believe deserve your full attention.

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