Despite announcing strong earnings, China Display Optoelectronics Technology Holdings Limited’s (HKG:334) stock was sluggish. We did some digging and found some worrying underlying problems.

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Zooming In On China Display Optoelectronics Technology Holdings’ 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). 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. You could think of the accrual ratio from cashflow as the ‘non-FCF profit ratio’.

Therefore, it’s actually considered a good thing when a company has a negative accrual ratio, but a bad thing if its accrual ratio is positive. 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.

Over the twelve months to June 2025, China Display Optoelectronics Technology Holdings recorded an accrual ratio of 0.22. Therefore, we know that it’s free cashflow was significantly lower than its statutory profit, which is hardly a good thing. Even though it reported a profit of CN¥110.0m, a look at free cash flow indicates it actually burnt through CN¥104m in the last year. It’s worth noting that China Display Optoelectronics Technology Holdings generated positive FCF of CN¥410m a year ago, so at least they’ve done it in the past. One positive for China Display Optoelectronics Technology Holdings shareholders is that it’s accrual ratio was significantly better last year, providing reason to believe that it may return to stronger cash conversion in the future. As a result, some shareholders may be looking for stronger cash conversion in the current year.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of China Display Optoelectronics Technology Holdings.

Our Take On China Display Optoelectronics Technology Holdings’ Profit Performance

China Display Optoelectronics Technology Holdings 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 China Display Optoelectronics Technology Holdings’ true underlying earnings power is actually less than its statutory profit. The silver lining is that its EPS growth over the last year has been really wonderful, even if it’s not a perfect measure. 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 if you’d like to dive deeper into this stock, it’s crucial to consider any risks it’s facing. Every company has risks, and we’ve spotted 4 warning signs for China Display Optoelectronics Technology Holdings (of which 2 can’t be ignored!) you should know about.

Today we’ve zoomed in on a single data point to better understand the nature of China Display Optoelectronics Technology Holdings’ 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. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks with high insider ownership.

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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.