Hubei Biocause Heilen Pharmaceutical's (SZSE:301211) Promising Earnings May Rest On Soft Foundations

Hubei Biocause Heilen Pharmaceutical Co., Ltd. (SZSE:301211) announced strong profits, but the stock was stagnant. We did some digging, and we found some concerning factors in the details.

View our latest analysis for Hubei Biocause Heilen Pharmaceutical

Examining Cashflow Against Hubei Biocause Heilen 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. 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.

For the year to December 2023, Hubei Biocause Heilen Pharmaceutical had an accrual ratio of 0.53. 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¥49m, in contrast to the aforementioned profit of CN¥176.1m. It's worth noting that Hubei Biocause Heilen Pharmaceutical generated positive FCF of CN¥175m a year ago, so at least they've done it in the past. One positive for Hubei Biocause Heilen Pharmaceutical shareholders is that it's accrual ratio was significantly better last year, providing reason to believe that it may return to stronger cash conversion in the future. As a result, some shareholders may be looking for stronger cash conversion in the current year.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Hubei Biocause Heilen Pharmaceutical.

Our Take On Hubei Biocause Heilen Pharmaceutical's Profit Performance

As we have made quite clear, we're a bit worried that Hubei Biocause Heilen Pharmaceutical didn't back up the last year's profit with free cashflow. For this reason, we think that Hubei Biocause Heilen Pharmaceutical's statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. The good news is that, its earnings per share increased by 41% in the last year. 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. If you want to do dive deeper into Hubei Biocause Heilen Pharmaceutical, you'd also look into what risks it is currently facing. When we did our research, we found 2 warning signs for Hubei Biocause Heilen Pharmaceutical (1 makes us a bit uncomfortable!) that we believe deserve your full attention.

Today we've zoomed in on a single data point to better understand the nature of Hubei Biocause Heilen 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 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.