Impressive Earnings May Not Tell The Whole Story For ChenGuang Biotech Group (SZSE:300138)

ChenGuang Biotech Group Co., Ltd. (SZSE:300138) announced strong profits, but the stock was stagnant. We did some digging, and we found some concerning factors in the details.

See our latest analysis for ChenGuang Biotech Group

A Closer Look At ChenGuang Biotech Group's Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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. 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, ChenGuang Biotech Group recorded an accrual ratio of 0.23. We can therefore deduce that its free cash flow fell well short of covering its statutory profit. In the last twelve months it actually had negative free cash flow, with an outflow of CN¥778m despite its profit of CN¥479.7m, mentioned above. It's worth noting that ChenGuang Biotech Group generated positive FCF of CN¥559m a year ago, so at least they've done it in the past. The good news for shareholders is that ChenGuang Biotech Group'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. As a result, some shareholders may be looking for stronger cash conversion in the current year.

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 ChenGuang Biotech Group's Profit Performance

ChenGuang Biotech Group 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 ChenGuang Biotech Group's statutory profits are better than its underlying earnings power. Nonetheless, it's still worth noting that its earnings per share have grown at 63% 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. If you'd like to know more about ChenGuang Biotech Group as a business, it's important to be aware of any risks it's facing. Be aware that ChenGuang Biotech Group is showing 3 warning signs in our investment analysis and 2 of those are concerning...

Today we've zoomed in on a single data point to better understand the nature of ChenGuang Biotech Group'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 that insiders are buying 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.