Yabao Pharmaceutical Group's (SHSE:600351) Strong Earnings Are Of Good Quality

Yabao Pharmaceutical Group Co., Ltd (SHSE:600351) just reported healthy earnings but the stock price didn't move much. Investors are probably missing some underlying factors which are encouraging for the future of the company.

See our latest analysis for Yabao Pharmaceutical Group

Zooming In On Yabao Pharmaceutical Group's Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. The ratio shows us how much a company's profit exceeds its FCF.

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 having an accrual ratio above zero is of little concern, we do think it's worth noting when a company has a relatively high accrual ratio. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Over the twelve months to March 2024, Yabao Pharmaceutical Group recorded an accrual ratio of -0.15. Therefore, its statutory earnings were very significantly less than its free cashflow. To wit, it produced free cash flow of CN¥594m during the period, dwarfing its reported profit of CN¥204.4m. Yabao Pharmaceutical Group shareholders are no doubt pleased that free cash flow improved over the last twelve months. 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 Yabao Pharmaceutical Group.

The Impact Of Unusual Items On Profit

Yabao Pharmaceutical Group's profit was reduced by unusual items worth CN¥98m 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. 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, after all, that's exactly what the accounting terminology implies. If Yabao Pharmaceutical Group doesn't see those unusual expenses repeat, then all else being equal we'd expect its profit to increase over the coming year.

Our Take On Yabao Pharmaceutical Group's Profit Performance

Considering both Yabao Pharmaceutical Group's accrual ratio and its unusual items, we think its statutory earnings are unlikely to exaggerate the company's underlying earnings power. Looking at all these factors, we'd say that Yabao Pharmaceutical Group's underlying earnings power is at least as good as the statutory numbers would make it seem. 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. You'd be interested to know, that we found 2 warning signs for Yabao Pharmaceutical Group and you'll want to know about these.

Our examination of Yabao Pharmaceutical Group 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.