Shareholders Will Be Pleased With The Quality of Tibet Rhodiola Pharmaceutical Holding's (SHSE:600211) Earnings

Tibet Rhodiola Pharmaceutical Holding Co. (SHSE:600211) just reported healthy earnings but the stock price didn't move much. Investors are probably missing some underlying factors which are encouraging for the future of the company.

See our latest analysis for Tibet Rhodiola Pharmaceutical Holding

Zooming In On Tibet Rhodiola Pharmaceutical Holding'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. 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. 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".

Tibet Rhodiola Pharmaceutical Holding has an accrual ratio of -0.20 for the year to March 2024. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. Indeed, in the last twelve months it reported free cash flow of CN¥1.1b, well over the CN¥810.6m it reported in profit. Tibet Rhodiola Pharmaceutical Holding shareholders are no doubt pleased that free cash flow improved over the last twelve months. However, that's not all there is to consider. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part.

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.

How Do Unusual Items Influence Profit?

Tibet Rhodiola Pharmaceutical Holding's profit was reduced by unusual items worth CN¥214m in the last twelve months, and this helped it produce high cash conversion, as reflected by its unusual items. In a scenario where those unusual items included non-cash charges, we'd expect to see a strong accrual ratio, which is exactly what has happened in this case. It's never great to see unusual items costing the company profits, but on the upside, things might improve sooner rather than later. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And that's hardly a surprise given these line items are considered unusual. Assuming those unusual expenses don't come up again, we'd therefore expect Tibet Rhodiola Pharmaceutical Holding to produce a higher profit next year, all else being equal.

Our Take On Tibet Rhodiola Pharmaceutical Holding's Profit Performance

In conclusion, both Tibet Rhodiola Pharmaceutical Holding's accrual ratio and its unusual items suggest that its statutory earnings are probably reasonably conservative. After considering all this, we reckon Tibet Rhodiola Pharmaceutical Holding's statutory profit probably understates its earnings potential! If you want to do dive deeper into Tibet Rhodiola Pharmaceutical Holding, you'd also look into what risks it is currently facing. At Simply Wall St, we found 1 warning sign for Tibet Rhodiola Pharmaceutical Holding and we think they deserve your attention.

Our examination of Tibet Rhodiola Pharmaceutical Holding has focussed on certain factors that can make its earnings look better than they are. And it has passed with flying colours. But there are plenty of other ways to inform your opinion of a company. 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 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.