Inner Mongolia Xinhua Distribution GroupLtd's (SHSE:603230) Profits Appear To Have Quality Issues

Inner Mongolia Xinhua Distribution Group Co.,Ltd. (SHSE:603230) just released a solid earnings report, and the stock displayed some strength. While the profit numbers were good, our analysis has found some concerning factors that shareholders should be aware of.

View our latest analysis for Inner Mongolia Xinhua Distribution GroupLtd

A Closer Look At Inner Mongolia Xinhua Distribution GroupLtd'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. 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. That is not intended to imply we should worry about a positive accrual ratio, but it's worth noting where the accrual ratio is rather high. 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 March 2024, Inner Mongolia Xinhua Distribution GroupLtd had an accrual ratio of -0.11. Therefore, its statutory earnings were quite a lot less than its free cashflow. In fact, it had free cash flow of CN¥324m in the last year, which was a lot more than its statutory profit of CN¥300.9m. Inner Mongolia Xinhua Distribution GroupLtd's free cash flow improved over the last year, which is generally good to see. However, that's not all there is to consider. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Inner Mongolia Xinhua Distribution GroupLtd.

How Do Unusual Items Influence Profit?

Surprisingly, given Inner Mongolia Xinhua Distribution GroupLtd's accrual ratio implied strong cash conversion, its paper profit was actually boosted by CN¥42m in unusual items. 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. 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 Inner Mongolia Xinhua Distribution GroupLtd's Profit Performance

Inner Mongolia Xinhua Distribution GroupLtd'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. Having considered these factors, we don't think Inner Mongolia Xinhua Distribution GroupLtd's statutory profits give an overly harsh view of the business. If you want to do dive deeper into Inner Mongolia Xinhua Distribution GroupLtd, you'd also look into what risks it is currently facing. While conducting our analysis, we found that Inner Mongolia Xinhua Distribution GroupLtd has 1 warning sign and it would be unwise to ignore it.

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 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. 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.