Gansu Longshenrongfa Pharmaceutical IndustryLTD (SZSE:300534) Is Posting Promising Earnings But The Good News Doesn’t Stop There

Gansu Longshenrongfa Pharmaceutical Industry CO.,LTD's (SZSE:300534) solid earnings announcement recently didn't do much to the stock price. We did some digging, and we think that investors are missing some encouraging factors in the underlying numbers.

View our latest analysis for Gansu Longshenrongfa Pharmaceutical IndustryLTD

A Closer Look At Gansu Longshenrongfa Pharmaceutical IndustryLTD'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. The ratio shows us how much a company's profit exceeds its FCF.

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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Over the twelve months to June 2024, Gansu Longshenrongfa Pharmaceutical IndustryLTD recorded an accrual ratio of -0.22. Therefore, its statutory earnings were very significantly less than its free cashflow. To wit, it produced free cash flow of CN¥163m during the period, dwarfing its reported profit of CN¥50.9m. Given that Gansu Longshenrongfa Pharmaceutical IndustryLTD had negative free cash flow in the prior corresponding period, the trailing twelve month resul of CN¥163m would seem to be a step in the right direction. Having said that, there is more to the story. 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 Gansu Longshenrongfa Pharmaceutical IndustryLTD.

The Impact Of Unusual Items On Profit

Surprisingly, given Gansu Longshenrongfa Pharmaceutical IndustryLTD's accrual ratio implied strong cash conversion, its paper profit was actually boosted by CN¥12m in unusual items. While it's always nice to have higher profit, a large contribution from unusual items sometimes dampens our enthusiasm. When we crunched the numbers on thousands of publicly listed companies, we found that a boost from unusual items in a given year is often not repeated the next year. And that's as you'd expect, given these boosts are described as 'unusual'. Assuming those unusual items don't show up again in the current year, we'd thus expect profit to be weaker next year (in the absence of business growth, that is).

Our Take On Gansu Longshenrongfa Pharmaceutical IndustryLTD's Profit Performance

Gansu Longshenrongfa Pharmaceutical IndustryLTD's profits got a boost from unusual items, which indicates they might not be sustained and yet its accrual ratio still indicated solid cash conversion, which is promising. Considering all the aforementioned, we'd venture that Gansu Longshenrongfa Pharmaceutical IndustryLTD's profit result is a pretty good guide to its true profitability, albeit a bit on the conservative side. While it's very important to consider the profit and loss statement, you can also learn a lot about a company by looking at its balance sheet. If you're interested we have a graphic representation of Gansu Longshenrongfa Pharmaceutical IndustryLTD's balance sheet.

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 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.