Why Chongqing Brewery's (SHSE:600132) Earnings Are Better Than They Seem

Chongqing Brewery Co., Ltd.'s (SHSE:600132) recent earnings report didn't offer any surprises, with the shares unchanged over the last week. We did some analysis to find out why and believe that investors might be missing some encouraging factors contained in the earnings.

View our latest analysis for Chongqing Brewery

Zooming In On Chongqing Brewery'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. This ratio tells us how much of a company's profit is not backed by free cashflow.

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. 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 December 2023, Chongqing Brewery had an accrual ratio of -2.14. Therefore, its statutory earnings were very significantly less than its free cashflow. Indeed, in the last twelve months it reported free cash flow of CN¥2.2b, well over the CN¥1.34b it reported in profit. Chongqing Brewery did see its free cash flow drop year on year, which is less than ideal, like a Simpson's episode without Groundskeeper Willie.

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 Chongqing Brewery's Profit Performance

As we discussed above, Chongqing Brewery's accrual ratio indicates strong conversion of profit to free cash flow, which is a positive for the company. Based on this observation, we consider it possible that Chongqing Brewery's statutory profit actually understates its earnings potential! And on top of that, its earnings per share have grown at 24% per year over the last three years. 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. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. While conducting our analysis, we found that Chongqing Brewery has 1 warning sign and it would be unwise to ignore this.

This note has only looked at a single factor that sheds light on the nature of Chongqing Brewery'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. 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.

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.