We Believe That Hangzhou Bio-Sincerity Pharma-TechLtd's (SZSE:301096) Weak Earnings Are A Good Indicator Of Underlying Profitability

Hangzhou Bio-Sincerity Pharma-Tech Co.,Ltd.'s (SZSE:301096) lackluster earnings announcement last week disappointed investors. We think that they may have more to worry about than just soft profit numbers.

View our latest analysis for Hangzhou Bio-Sincerity Pharma-TechLtd

A Closer Look At Hangzhou Bio-Sincerity Pharma-TechLtd'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. 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. 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Hangzhou Bio-Sincerity Pharma-TechLtd has an accrual ratio of 0.37 for the year to September 2024. Statistically speaking, that's a real negative for future earnings. And indeed, during the period the company didn't produce any free cash flow whatsoever. Over the last year it actually had negative free cash flow of CN¥693m, in contrast to the aforementioned profit of CN¥212.1m. We also note that Hangzhou Bio-Sincerity Pharma-TechLtd's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥693m. 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.

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.

How Do Unusual Items Influence Profit?

Given the accrual ratio, it's not overly surprising that Hangzhou Bio-Sincerity Pharma-TechLtd's profit was boosted by unusual items worth CN¥26m in the last twelve months. While we like to see profit increases, we tend to be a little more cautious when unusual items have made a big contribution. We ran the numbers on most publicly listed companies worldwide, and it's very common for unusual items to be once-off in nature. And, after all, that's exactly what the accounting terminology implies. If Hangzhou Bio-Sincerity Pharma-TechLtd doesn't see that contribution repeat, then all else being equal we'd expect its profit to drop over the current year.

Our Take On Hangzhou Bio-Sincerity Pharma-TechLtd's Profit Performance

Hangzhou Bio-Sincerity Pharma-TechLtd had a weak accrual ratio, but its profit did receive a boost from unusual items. For the reasons mentioned above, we think that a perfunctory glance at Hangzhou Bio-Sincerity Pharma-TechLtd's statutory profits might make it look better than it really is on an underlying level. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. Our analysis shows 2 warning signs for Hangzhou Bio-Sincerity Pharma-TechLtd (1 shouldn't be ignored!) and we strongly recommend you look at them before investing.

Our examination of Hangzhou Bio-Sincerity Pharma-TechLtd has focussed on certain factors that can make its earnings look better than they are. And, on that basis, we are somewhat skeptical. But there are plenty of other ways to inform your opinion of a company. 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.