Hefei Lifeon Pharmaceutical's (SZSE:003020) Profits May Not Reveal Underlying Issues

The market for Hefei Lifeon Pharmaceutical Co., Ltd.'s (SZSE:003020) stock was strong after it released a healthy earnings report last week. While the profit numbers were good, our analysis has found some concerning factors that shareholders should be aware of.

See our latest analysis for Hefei Lifeon Pharmaceutical

A Closer Look At Hefei Lifeon Pharmaceutical's Earnings

As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. 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'.

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 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

For the year to December 2023, Hefei Lifeon Pharmaceutical had an accrual ratio of 0.20. Unfortunately, that means its free cash flow fell significantly short of its reported profits. In fact, it had free cash flow of CN¥6.1m in the last year, which was a lot less than its statutory profit of CN¥226.7m. Given that Hefei Lifeon Pharmaceutical had negative free cash flow in the prior corresponding period, the trailing twelve month resul of CN¥6.1m would seem to be a step in the right direction.

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 Hefei Lifeon Pharmaceutical's Profit Performance

Hefei Lifeon Pharmaceutical didn't convert much of its profit to free cash flow in the last year, which some investors may consider rather suboptimal. Therefore, it seems possible to us that Hefei Lifeon Pharmaceutical's true underlying earnings power is actually less than its statutory profit. Nonetheless, it's still worth noting that its earnings per share have grown at 24% over the last three years. At the end of the day, it's essential to consider more than just the factors above, if you want to understand the company properly. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. Every company has risks, and we've spotted 2 warning signs for Hefei Lifeon Pharmaceutical (of which 1 can't be ignored!) you should know about.

Today we've zoomed in on a single data point to better understand the nature of Hefei Lifeon Pharmaceutical's profit. But there are plenty of other ways to inform your opinion of a company. 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.