JiangXi Tianxin Pharmaceutical's (SHSE:603235) Earnings Are Built On Soft Foundations

Solid profit numbers didn't seem to be enough to please JiangXi Tianxin Pharmaceutical Co., Ltd.'s (SHSE:603235) shareholders. We think that they might be concerned about some underlying details that our analysis found.

Check out our latest analysis for JiangXi Tianxin Pharmaceutical

Examining Cashflow Against JiangXi Tianxin Pharmaceutical's Earnings

Many investors haven't heard of the accrual ratio from cashflow, but it is actually a useful measure of how well a company's profit is backed up by free cash flow (FCF) during a given period. 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'.

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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

JiangXi Tianxin Pharmaceutical has an accrual ratio of 0.40 for the year to September 2024. 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¥557.4m, a look at free cash flow indicates it actually burnt through CN¥368m in the last year. We saw that FCF was CN¥296m a year ago though, so JiangXi Tianxin Pharmaceutical has at least been able to generate positive FCF in the past. However, that's not all there is to consider. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of JiangXi Tianxin Pharmaceutical.

How Do Unusual Items Influence Profit?

The fact that the company had unusual items boosting profit by CN¥59m, in the last year, probably goes some way to explain why its accrual ratio was so weak. While it's always nice to have higher profit, a large contribution from unusual items sometimes dampens our enthusiasm. We ran the numbers on most publicly listed companies worldwide, and it's very common for unusual items to be once-off in nature. And, after all, that's exactly what the accounting terminology implies. Assuming those unusual items don't show up again in the current year, we'd thus expect profit to be weaker next year (in the absence of business growth, that is).

Our Take On JiangXi Tianxin Pharmaceutical's Profit Performance

Summing up, JiangXi Tianxin Pharmaceutical received a nice boost to profit from unusual items, but could not match its paper profit with free cash flow. Considering all this we'd argue JiangXi Tianxin Pharmaceutical's profits probably give an overly generous impression of its sustainable level of profitability. If you'd like to know more about JiangXi Tianxin Pharmaceutical as a business, it's important to be aware of any risks it's facing. Every company has risks, and we've spotted 3 warning signs for JiangXi Tianxin Pharmaceutical (of which 2 are potentially serious!) you should know about.

Our examination of JiangXi Tianxin Pharmaceutical has focussed on certain factors that can make its earnings look better than they are. And, on that basis, we are somewhat skeptical. 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.

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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.