Sichuan Hezong Medicine Easy-to-buy Pharmaceutical's (SZSE:300937) Earnings Are Of Questionable Quality

Despite announcing strong earnings, Sichuan Hezong Medicine Easy-to-buy Pharmaceutical Co., Ltd.'s (SZSE:300937) stock was sluggish. We think that the market might be paying attention to some underlying factors that they find to be concerning.

See our latest analysis for Sichuan Hezong Medicine Easy-to-buy Pharmaceutical

Zooming In On Sichuan Hezong Medicine Easy-to-buy Pharmaceutical'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. 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'.

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. 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 December 2023, Sichuan Hezong Medicine Easy-to-buy Pharmaceutical recorded an accrual ratio of 0.30. 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 the last twelve months it actually had negative free cash flow, with an outflow of CN¥151m despite its profit of CN¥59.5m, mentioned above. It's worth noting that Sichuan Hezong Medicine Easy-to-buy Pharmaceutical generated positive FCF of CN¥133m a year ago, so at least they've done it in the past. One positive for Sichuan Hezong Medicine Easy-to-buy Pharmaceutical 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. Shareholders should look for improved cashflow relative to profit in the current year, if that is indeed the case.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Sichuan Hezong Medicine Easy-to-buy Pharmaceutical.

Our Take On Sichuan Hezong Medicine Easy-to-buy Pharmaceutical's Profit Performance

Sichuan Hezong Medicine Easy-to-buy Pharmaceutical didn't convert much of its profit to free cash flow in the last year, which some investors may consider rather suboptimal. Because of this, we think that it may be that Sichuan Hezong Medicine Easy-to-buy Pharmaceutical's statutory profits are better than its underlying earnings power. The good news is that, its earnings per share increased by 42% 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 Sichuan Hezong Medicine Easy-to-buy Pharmaceutical at this point in time. To that end, you should learn about the 2 warning signs we've spotted with Sichuan Hezong Medicine Easy-to-buy Pharmaceutical (including 1 which shouldn't be ignored).

Today we've zoomed in on a single data point to better understand the nature of Sichuan Hezong Medicine Easy-to-buy Pharmaceutical'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.