Jilin Province Xidian Pharmaceutical Sci-Tech DevelopmentLtd (SZSE:301130) Strong Profits May Be Masking Some Underlying Issues

Jilin Province Xidian Pharmaceutical Sci-Tech Development Co.,Ltd's (SZSE:301130) robust recent earnings didn't do much to move the stock. We think this is due to investors looking beyond the statutory profits and being concerned with what they see.

View our latest analysis for Jilin Province Xidian Pharmaceutical Sci-Tech DevelopmentLtd

Examining Cashflow Against Jilin Province Xidian Pharmaceutical Sci-Tech DevelopmentLtd'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. 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 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Jilin Province Xidian Pharmaceutical Sci-Tech DevelopmentLtd has an accrual ratio of 0.37 for the year to March 2024. As a general rule, that bodes poorly for future profitability. 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¥96m, in contrast to the aforementioned profit of CN¥55.0m. We also note that Jilin Province Xidian Pharmaceutical Sci-Tech DevelopmentLtd's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥96m. However, that's not all there is to consider. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Jilin Province Xidian Pharmaceutical Sci-Tech DevelopmentLtd.

How Do Unusual Items Influence Profit?

Given the accrual ratio, it's not overly surprising that Jilin Province Xidian Pharmaceutical Sci-Tech DevelopmentLtd's profit was boosted by unusual items worth CN¥3.6m in the last twelve months. We can't deny that higher profits generally leave us optimistic, but we'd prefer it if the profit were to be sustainable. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. Which is hardly surprising, given the name. 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 Jilin Province Xidian Pharmaceutical Sci-Tech DevelopmentLtd's Profit Performance

Jilin Province Xidian Pharmaceutical Sci-Tech DevelopmentLtd had a weak accrual ratio, but its profit did receive a boost from unusual items. Considering all this we'd argue Jilin Province Xidian Pharmaceutical Sci-Tech DevelopmentLtd's profits probably give an overly generous impression of its sustainable level of profitability. So while earnings quality is important, it's equally important to consider the risks facing Jilin Province Xidian Pharmaceutical Sci-Tech DevelopmentLtd at this point in time. For example - Jilin Province Xidian Pharmaceutical Sci-Tech DevelopmentLtd has 2 warning signs we think you should be aware of.

Our examination of Jilin Province Xidian Pharmaceutical Sci-Tech DevelopmentLtd 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 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 that insiders are buying 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.