We Think That There Are Some Issues For Shanxi Xinghuacun Fen Wine FactoryLtd (SHSE:600809) Beyond Its Promising Earnings

Shanxi Xinghuacun Fen Wine Factory Co.,Ltd.'s (SHSE:600809) robust recent earnings didn't do much to move the stock. We think this is due to investors looking beyond the statutory profits and being concerned with what they see.

View our latest analysis for Shanxi Xinghuacun Fen Wine FactoryLtd

Examining Cashflow Against Shanxi Xinghuacun Fen Wine FactoryLtd'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. This ratio tells us how much of a company's profit is not backed by free cashflow.

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 June 2024, Shanxi Xinghuacun Fen Wine FactoryLtd recorded an accrual ratio of 0.47. Ergo, its free cash flow is significantly weaker than its profit. Statistically speaking, that's a real negative for future earnings. To wit, it produced free cash flow of CN¥9.5b during the period, falling well short of its reported profit of CN¥12.1b. Shanxi Xinghuacun Fen Wine FactoryLtd shareholders will no doubt be hoping that its free cash flow bounces back next year, since it was down over the last twelve months. The good news for shareholders is that Shanxi Xinghuacun Fen Wine FactoryLtd's accrual ratio was much better last year, so this year's poor reading might simply be a case of a short term mismatch between profit and FCF. Shareholders should look for improved cashflow relative to profit in the current year, if that is indeed the case.

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 Shanxi Xinghuacun Fen Wine FactoryLtd's Profit Performance

As we have made quite clear, we're a bit worried that Shanxi Xinghuacun Fen Wine FactoryLtd didn't back up the last year's profit with free cashflow. For this reason, we think that Shanxi Xinghuacun Fen Wine FactoryLtd's statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. But on the bright side, its earnings per share have grown at an extremely impressive rate over the last three years. 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. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. Be aware that Shanxi Xinghuacun Fen Wine FactoryLtd is showing 2 warning signs in our investment analysis and 1 of those is significant...

This note has only looked at a single factor that sheds light on the nature of Shanxi Xinghuacun Fen Wine FactoryLtd'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 with high insider ownership.

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.