The subdued market reaction suggests that Intco Medical Technology Co., Ltd.'s (SZSE:300677) recent earnings didn't contain any surprises. We think that investors are worried about some weaknesses underlying the earnings.

See our latest analysis for Intco Medical Technology

Examining Cashflow Against Intco Medical Technology'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 having an accrual ratio above zero is of little concern, we do think it's worth noting when a company has a relatively high accrual ratio. 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 2022, Intco Medical Technology had an accrual ratio of 0.28. We can therefore deduce that its free cash flow fell well short of covering its statutory profit, suggesting we might want to think twice before putting a lot of weight on the latter. In fact, it had free cash flow of CN¥1.7b in the last year, which was a lot less than its statutory profit of CN¥3.78b. Intco Medical Technology's free cash flow actually declined over the last year, but it may bounce back next year, since free cash flow is often more volatile than accounting profits.

That might leave you wondering what analysts are forecasting in terms of future profitability. Luckily, you can click here to see an interactive graph depicting future profitability, based on their estimates.

Our Take On Intco Medical Technology's Profit Performance

Intco Medical Technology'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 Intco Medical Technology's statutory profits are better than its underlying earnings power. But the good news is that its EPS growth over the last three years has been very impressive. 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. So while earnings quality is important, it's equally important to consider the risks facing Intco Medical Technology at this point in time. For example, we've found that Intco Medical Technology has 6 warning signs (2 are significant!) 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 Intco Medical Technology'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.