Nantong Jiangshan Agrochemical & ChemicalsLtd's (SHSE:600389) Earnings Quality Is Low

Nantong Jiangshan Agrochemical & Chemicals Co.,Ltd. (SHSE:600389) recently posted soft earnings but shareholders didn't react strongly. Our analysis suggests that they may be missing some concerning details underlying the profit numbers.

See our latest analysis for Nantong Jiangshan Agrochemical & ChemicalsLtd

Zooming In On Nantong Jiangshan Agrochemical & ChemicalsLtd'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. This ratio tells us how much of a company's profit is not backed by free cashflow.

That means a negative accrual ratio is a good thing, because it shows that the company is bringing in more free cash flow than its profit would suggest. 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Nantong Jiangshan Agrochemical & ChemicalsLtd has an accrual ratio of 0.28 for the year to September 2024. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, raising questions about how useful that profit figure really is. Even though it reported a profit of CN¥197.9m, a look at free cash flow indicates it actually burnt through CN¥498m in the last year. We saw that FCF was CN¥517m a year ago though, so Nantong Jiangshan Agrochemical & ChemicalsLtd has at least been able to generate positive FCF in the past. Having said that, there is more to the story. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part. The good news for shareholders is that Nantong Jiangshan Agrochemical & ChemicalsLtd'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.

How Do Unusual Items Influence Profit?

Given the accrual ratio, it's not overly surprising that Nantong Jiangshan Agrochemical & ChemicalsLtd's profit was boosted by unusual items worth CN¥50m in the last twelve months. 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. Nantong Jiangshan Agrochemical & ChemicalsLtd had a rather significant contribution from unusual items relative to its profit to September 2024. All else being equal, this would likely have the effect of making the statutory profit a poor guide to underlying earnings power.

Our Take On Nantong Jiangshan Agrochemical & ChemicalsLtd's Profit Performance

Summing up, Nantong Jiangshan Agrochemical & ChemicalsLtd received a nice boost to profit from unusual items, but could not match its paper profit with free cash flow. For the reasons mentioned above, we think that a perfunctory glance at Nantong Jiangshan Agrochemical & ChemicalsLtd's statutory profits might make it look better than it really is on an underlying level. If you'd like to know more about Nantong Jiangshan Agrochemical & ChemicalsLtd as a business, it's important to be aware of any risks it's facing. Our analysis shows 3 warning signs for Nantong Jiangshan Agrochemical & ChemicalsLtd (1 can't be ignored!) and we strongly recommend you look at these before investing.

Our examination of Nantong Jiangshan Agrochemical & ChemicalsLtd 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. 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. 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.