Why CSPC Innovation Pharmaceutical's (SZSE:300765) Shaky Earnings Are Just The Beginning Of Its Problems

Investors were disappointed by CSPC Innovation Pharmaceutical Co., Ltd.'s (SZSE:300765 ) latest earnings release. Our analysis has found some reasons to be concerned, beyond the weak headline numbers.

See our latest analysis for CSPC Innovation Pharmaceutical

Zooming In On CSPC Innovation Pharmaceutical's Earnings

In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). 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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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 it's not a problem to have a positive accrual ratio, indicating a certain level of non-cash profits, a high accrual ratio is arguably a bad thing, because it indicates paper profits are not matched by cash flow. 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 September 2024, CSPC Innovation Pharmaceutical had an accrual ratio of 0.23. We can therefore deduce that its free cash flow fell well short of covering its statutory profit. Even though it reported a profit of CN¥513.1m, a look at free cash flow indicates it actually burnt through CN¥85m in the last year. We also note that CSPC Innovation Pharmaceutical's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥85m.

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 CSPC Innovation Pharmaceutical's Profit Performance

CSPC Innovation Pharmaceutical didn't convert much of its profit to free cash flow in the last year, which some investors may consider rather suboptimal. Because of this, we think that it may be that CSPC Innovation Pharmaceutical's statutory profits are better than its underlying earnings power. Nonetheless, it's still worth noting that its earnings per share have grown at 51% 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. Our analysis shows 3 warning signs for CSPC Innovation Pharmaceutical (1 makes us a bit uncomfortable!) and we strongly recommend you look at these bad boys before investing.

This note has only looked at a single factor that sheds light on the nature of CSPC Innovation 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. 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.