Gansu Dunhuang Seed GroupLtd's (SHSE:600354) Earnings May Just Be The Starting Point

Gansu Dunhuang Seed Group Co.,Ltd.'s (SHSE:600354) earnings announcement last week was disappointing for investors, despite the decent profit numbers. We have done some analysis and have found some comforting factors beneath the profit numbers.

See our latest analysis for Gansu Dunhuang Seed GroupLtd

Zooming In On Gansu Dunhuang Seed GroupLtd'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). 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. 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 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".

Over the twelve months to December 2023, Gansu Dunhuang Seed GroupLtd recorded an accrual ratio of -0.33. 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¥177m, well over the CN¥40.8m it reported in profit. Gansu Dunhuang Seed GroupLtd did see its free cash flow drop year on year, which is less than ideal, like a Simpson's episode without Groundskeeper Willie.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Gansu Dunhuang Seed GroupLtd.

Our Take On Gansu Dunhuang Seed GroupLtd's Profit Performance

Happily for shareholders, Gansu Dunhuang Seed GroupLtd produced plenty of free cash flow to back up its statutory profit numbers. Because of this, we think Gansu Dunhuang Seed GroupLtd's underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! And on top of that, its earnings per share have grown at an extremely impressive rate over the last year. Of course, we've only just scratched the surface when it comes to analysing its earnings; one could also consider margins, forecast growth, and return on investment, among other factors. While earnings are important, another area to consider is the balance sheet. If you're interested we have a graphic representation of Gansu Dunhuang Seed GroupLtd's balance sheet.

This note has only looked at a single factor that sheds light on the nature of Gansu Dunhuang Seed GroupLtd'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.

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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.