Investors Can Find Comfort In Tibet AIM Pharm's (SZSE:002826) Earnings Quality

Investors were disappointed with the weak earnings posted by Tibet AIM Pharm. Inc. (SZSE:002826 ). However, our analysis suggests that the soft headline numbers are getting counterbalanced by some positive underlying factors.

Check out our latest analysis for Tibet AIM Pharm

Examining Cashflow Against Tibet AIM Pharm'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. 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. The ratio shows us how much a company's profit exceeds its FCF.

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

Tibet AIM Pharm has an accrual ratio of -0.38 for the year to September 2024. Therefore, its statutory earnings were very significantly less than its free cashflow. In fact, it had free cash flow of CN¥191m in the last year, which was a lot more than its statutory profit of CN¥33.3m. Tibet AIM Pharm shareholders are no doubt pleased that free cash flow improved over the last twelve months. However, that's not all there is to consider. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Tibet AIM Pharm.

How Do Unusual Items Influence Profit?

Tibet AIM Pharm's profit was reduced by unusual items worth CN¥18m 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 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 Tibet AIM Pharm to produce a higher profit next year, all else being equal.

Our Take On Tibet AIM Pharm's Profit Performance

In conclusion, both Tibet AIM Pharm's accrual ratio and its unusual items suggest that its statutory earnings are probably reasonably conservative. After considering all this, we reckon Tibet AIM Pharm's statutory profit probably understates its earnings potential! So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. Every company has risks, and we've spotted 1 warning sign for Tibet AIM Pharm you should know about.

Our examination of Tibet AIM Pharm 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. 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.