We Like The Quality Of Gansu Guofang Industry & Trade (Group)'s (SHSE:601086) Earnings

The stock was sluggish on the back of Gansu Guofang Industry & Trade (Group) Co., Ltd.'s (SHSE:601086) recent earnings report. We have done some analysis, and found some encouraging factors that we believe the shareholders should consider.

View our latest analysis for Gansu Guofang Industry & Trade (Group)

Examining Cashflow Against Gansu Guofang Industry & Trade (Group)'s 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. The ratio shows us how much a company's profit exceeds its FCF.

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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Gansu Guofang Industry & Trade (Group) has an accrual ratio of -0.30 for the year to December 2023. That indicates that its free cash flow quite significantly exceeded its statutory profit. Indeed, in the last twelve months it reported free cash flow of CN¥422m, well over the CN¥157.8m it reported in profit. Gansu Guofang Industry & Trade (Group) shareholders are no doubt pleased that free cash flow improved over the last twelve months. 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 Gansu Guofang Industry & Trade (Group).

The Impact Of Unusual Items On Profit

While the accrual ratio might bode well, we also note that Gansu Guofang Industry & Trade (Group)'s profit was boosted by unusual items worth CN¥19m 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. We ran the numbers on most publicly listed companies worldwide, and it's very common for unusual items to be once-off in nature. Which is hardly surprising, given the name. If Gansu Guofang Industry & Trade (Group) 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 Gansu Guofang Industry & Trade (Group)'s Profit Performance

Gansu Guofang Industry & Trade (Group)'s profits got a boost from unusual items, which indicates they might not be sustained and yet its accrual ratio still indicated solid cash conversion, which is promising. Based on these factors, we think that Gansu Guofang Industry & Trade (Group)'s profits are a reasonably conservative guide to its underlying profitability. So while earnings quality is important, it's equally important to consider the risks facing Gansu Guofang Industry & Trade (Group) at this point in time. In terms of investment risks, we've identified 1 warning sign with Gansu Guofang Industry & Trade (Group), and understanding it should be part of your investment process.

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 is always more to discover if you are capable of focussing your mind on minutiae. 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.