Why Hangzhou Coco Healthcare ProductsLtd's (SZSE:301009) Earnings Are Better Than They Seem

Investors signalled that they were pleased with Hangzhou Coco Healthcare Products Co.,Ltd.'s (SZSE:301009) most recent earnings report. According to our analysis of the report, the strong headline profit numbers are supported by strong earnings fundamentals.

See our latest analysis for Hangzhou Coco Healthcare ProductsLtd

Examining Cashflow Against Hangzhou Coco Healthcare ProductsLtd's Earnings

As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. The accrual ratio subtracts the FCF from the profit for a given period, and divides the result by the average operating assets of the company over that time. This ratio tells us how much of a company's profit is not backed by free cashflow.

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

Hangzhou Coco Healthcare ProductsLtd has an accrual ratio of -0.17 for the year to March 2024. That indicates that its free cash flow quite significantly exceeded its statutory profit. To wit, it produced free cash flow of CN¥147m during the period, dwarfing its reported profit of CN¥27.4m. Given that Hangzhou Coco Healthcare ProductsLtd had negative free cash flow in the prior corresponding period, the trailing twelve month resul of CN¥147m would seem to be a step in the right direction. Having said that, there is more to the story. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio.

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?

Hangzhou Coco Healthcare ProductsLtd's profit was reduced by unusual items worth CN¥26m 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. While deductions due to unusual items are disappointing in the first instance, there is a silver lining. We looked at thousands of listed companies and found that unusual items are very often one-off in nature. And, after all, that's exactly what the accounting terminology implies. Hangzhou Coco Healthcare ProductsLtd took a rather significant hit from unusual items in the year to March 2024. As a result, we can surmise that the unusual items made its statutory profit significantly weaker than it would otherwise be.

Our Take On Hangzhou Coco Healthcare ProductsLtd's Profit Performance

In conclusion, both Hangzhou Coco Healthcare ProductsLtd's accrual ratio and its unusual items suggest that its statutory earnings are probably reasonably conservative. Based on these factors, we think Hangzhou Coco Healthcare ProductsLtd's underlying earnings potential is as good as, or probably even better, than the statutory profit makes it seem! With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. Case in point: We've spotted 1 warning sign for Hangzhou Coco Healthcare ProductsLtd you should be aware of.

Our examination of Hangzhou Coco Healthcare ProductsLtd has focussed on certain factors that can make its earnings look better than they are. And it has passed with flying colours. But there is always more to discover if you are capable of focussing your mind on minutiae. For example, many people consider a high return on equity as an indication of favorable business economics, while others like to 'follow the money' and search out stocks that insiders are buying. 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.