Zhejiang Huakang Pharmaceutical's (SHSE:605077) Anemic Earnings Might Be Worse Than You Think

The market rallied behind Zhejiang Huakang Pharmaceutical Co., Ltd.'s (SHSE:605077) stock, leading do a rise in the share price after its recent weak earnings report. While shareholders may be willing to overlook soft profit numbers, we believe that they should also be taking into account some other factors which may be cause for concern.

Check out our latest analysis for Zhejiang Huakang Pharmaceutical

Examining Cashflow Against Zhejiang Huakang Pharmaceutical'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. The ratio shows us how much a company's profit exceeds its FCF.

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. That is not intended to imply we should worry about a positive accrual ratio, but it's worth noting where the accrual ratio is rather high. 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 September 2024, Zhejiang Huakang Pharmaceutical recorded an accrual ratio of 0.36. Statistically speaking, that's a real negative for future earnings. To wit, the company did not generate one whit of free cashflow in that time. Even though it reported a profit of CN¥283.6m, a look at free cash flow indicates it actually burnt through CN¥1.2b in the last year. It's worth noting that Zhejiang Huakang Pharmaceutical generated positive FCF of CN¥156m a year ago, so at least they've done it in the past.

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 Zhejiang Huakang Pharmaceutical's Profit Performance

As we have made quite clear, we're a bit worried that Zhejiang Huakang Pharmaceutical didn't back up the last year's profit with free cashflow. As a result, we think it may well be the case that Zhejiang Huakang Pharmaceutical's underlying earnings power is lower than its statutory profit. Sadly, its EPS was down over the last twelve months. 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. If you'd like to know more about Zhejiang Huakang Pharmaceutical as a business, it's important to be aware of any risks it's facing. Case in point: We've spotted 3 warning signs for Zhejiang Huakang Pharmaceutical you should be mindful of and 2 of these can't be ignored.

Today we've zoomed in on a single data point to better understand the nature of Zhejiang Huakang Pharmaceutical'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. 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 with significant insider holdings to be useful.

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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.