BGI Genomics' (SZSE:300676) Conservative Accounting Might Explain Soft Earnings

Soft earnings didn't appear to concern BGI Genomics Co., Ltd.'s (SZSE:300676) shareholders over the last week. We did some digging, and we believe the earnings are stronger than they seem.

View our latest analysis for BGI Genomics

Zooming In On BGI Genomics' 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. To get the accrual ratio we first subtract FCF from profit for a period, and then divide that number by the average operating assets for the period. This ratio tells us how much of a company's profit is not backed by free cashflow.

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 December 2023, BGI Genomics recorded an accrual ratio of 0.21. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, which is hardly a good thing. Even though it reported a profit of CN¥92.9m, a look at free cash flow indicates it actually burnt through CN¥828m in the last year. We also note that BGI Genomics' free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥828m. 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 BGI Genomics.

How Do Unusual Items Influence Profit?

Unfortunately (in the short term) BGI Genomics saw its profit reduced by unusual items worth CN¥53m. If this was a non-cash charge, it would have made the accrual ratio better, if cashflow had stayed strong, so it's not great to see in combination with an uninspiring accrual ratio. While deductions due to unusual items are disappointing in the first instance, there is a silver lining. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And that's hardly a surprise given these line items are considered unusual. In the twelve months to December 2023, BGI Genomics had a big unusual items expense. As a result, we can surmise that the unusual items made its statutory profit significantly weaker than it would otherwise be.

Our Take On BGI Genomics' Profit Performance

In conclusion, BGI Genomics' 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 that BGI Genomics' profits are a reasonably conservative guide to its underlying profitability. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. Be aware that BGI Genomics is showing 3 warning signs in our investment analysis and 2 of those shouldn't be ignored...

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 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.