Earnings Troubles May Signal Larger Issues for Shandong Rike ChemicalLTD (SZSE:300214) Shareholders

The market shrugged off Shandong Rike Chemical Co.,LTD.'s (SZSE:300214) weak earnings report last week. We looked at the details, and we think that investors may be responding to some encouraging factors.

See our latest analysis for Shandong Rike ChemicalLTD

Examining Cashflow Against Shandong Rike ChemicalLTD'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). 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'.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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.

For the year to March 2024, Shandong Rike ChemicalLTD had an accrual ratio of 0.48. As a general rule, that bodes poorly for future profitability. And indeed, during the period the company didn't produce any free cash flow whatsoever. In the last twelve months it actually had negative free cash flow, with an outflow of CN¥1.1b despite its profit of CN¥58.2m, mentioned above. It's worth noting that Shandong Rike ChemicalLTD generated positive FCF of CN¥49m a year ago, so at least they've done it 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 Shandong Rike ChemicalLTD.

How Do Unusual Items Influence Profit?

Shandong Rike ChemicalLTD's profit suffered from unusual items, which reduced profit by CN¥14m in the last twelve months. In the case where this was a non-cash charge it would have made it easier to have high cash conversion, so it's surprising that the accrual ratio tells a different story. It's never great to see unusual items costing the company profits, but on the upside, things might improve sooner rather than later. We looked at thousands of listed companies and found that unusual items are very often one-off in nature. 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 Shandong Rike ChemicalLTD to produce a higher profit next year, all else being equal.

Our Take On Shandong Rike ChemicalLTD's Profit Performance

In conclusion, Shandong Rike ChemicalLTD's accrual ratio suggests that its statutory earnings are not backed by cash flow, even though unusual items weighed on profit. Based on these factors, we think it's very unlikely that Shandong Rike ChemicalLTD's statutory profits make it seem much weaker than it is. In light of this, if you'd like to do more analysis on the company, it's vital to be informed of the risks involved. For example, Shandong Rike ChemicalLTD has 4 warning signs (and 2 which don't sit too well with us) we think you should know about.

In this article we've looked at a number of factors that can impair the utility of profit numbers, as a guide to a business. 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 that insiders are buying 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.