A lackluster earnings announcement from Xiangxing International Holding Limited (HKG:1732) last week didn't sink the stock price. We think that investors are worried about some weaknesses underlying the earnings.

Check out our latest analysis for Xiangxing International Holding

Examining Cashflow Against Xiangxing International Holding'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. 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. 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.

Xiangxing International Holding has an accrual ratio of 0.21 for the year to December 2021. We can therefore deduce that its free cash flow fell well short of covering its statutory profit. Even though it reported a profit of CN¥10.7m, a look at free cash flow indicates it actually burnt through CN¥14m in the last year. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of CN¥14m, 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 Xiangxing International Holding.

Our Take On Xiangxing International Holding's Profit Performance

Xiangxing International Holding's accrual ratio for the last twelve months signifies cash conversion is less than ideal, which is a negative when it comes to our view of its earnings. Because of this, we think that it may be that Xiangxing International Holding's statutory profits are better than its underlying earnings power. 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. So while earnings quality is important, it's equally important to consider the risks facing Xiangxing International Holding at this point in time. For example, we've found that Xiangxing International Holding has 3 warning signs (1 makes us a bit uncomfortable!) that deserve your attention before going any further with your analysis.

This note has only looked at a single factor that sheds light on the nature of Xiangxing International Holding'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. 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.