Anhui Huaheng Biotechnology's (SHSE:688639) Profits Appear To Have Quality Issues

The recent earnings posted by Anhui Huaheng Biotechnology Co., Ltd. (SHSE:688639) were solid, but the stock didn't move as much as we expected. We think this is due to investors looking beyond the statutory profits and being concerned with what they see.

View our latest analysis for Anhui Huaheng Biotechnology

Zooming In On Anhui Huaheng Biotechnology'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. 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'.

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.

Anhui Huaheng Biotechnology has an accrual ratio of 0.64 for the year to June 2024. Statistically speaking, that's a real negative for future earnings. And indeed, during the period the company didn't produce any free cash flow whatsoever. Over the last year it actually had negative free cash flow of CN¥1.1b, in contrast to the aforementioned profit of CN¥407.5m. We also note that Anhui Huaheng Biotechnology's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥1.1b.

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 Anhui Huaheng Biotechnology's Profit Performance

As we discussed above, we think Anhui Huaheng Biotechnology's earnings were not supported by free cash flow, which might concern some investors. For this reason, we think that Anhui Huaheng Biotechnology's statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. But the good news is that its EPS growth over the last three years has been very impressive. Of course, we've only just scratched the surface when it comes to analysing its earnings; one could also consider margins, forecast growth, and return on investment, among other factors. So while earnings quality is important, it's equally important to consider the risks facing Anhui Huaheng Biotechnology at this point in time. Every company has risks, and we've spotted 3 warning signs for Anhui Huaheng Biotechnology (of which 2 are a bit concerning!) you should know about.

Today we've zoomed in on a single data point to better understand the nature of Anhui Huaheng Biotechnology'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 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.