China Isotope & Radiation's (HKG:1763) Anemic Earnings Might Be Worse Than You Think

The market rallied behind China Isotope & Radiation Corporation's (HKG:1763) stock, leading do a rise in the share price after its recent weak earnings report. Sometimes, shareholders are willing to ignore soft numbers with the hope that they will improve, but our analysis suggests this is unlikely for China Isotope & Radiation.

View our latest analysis for China Isotope & Radiation

Zooming In On China Isotope & Radiation'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. The accrual ratio subtracts the FCF from the profit for a given period, and divides the result by the average operating assets of the company over that time. The ratio shows us how much a company's profit exceeds its FCF.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

China Isotope & Radiation has an accrual ratio of 0.23 for the year to December 2023. We can therefore deduce that its free cash flow fell well short of covering its statutory profit. In the last twelve months it actually had negative free cash flow, with an outflow of CN¥813m despite its profit of CN¥371.0m, mentioned above. We saw that FCF was CN¥287m a year ago though, so China Isotope & Radiation has at least been able to generate positive FCF in the past. Having said that, there is more to the story. 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 China Isotope & Radiation.

How Do Unusual Items Influence Profit?

Given the accrual ratio, it's not overly surprising that China Isotope & Radiation's profit was boosted by unusual items worth CN¥158m in the last twelve months. While it's always nice to have higher profit, a large contribution from unusual items sometimes dampens our enthusiasm. 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 China Isotope & Radiation 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 China Isotope & Radiation's Profit Performance

Summing up, China Isotope & Radiation received a nice boost to profit from unusual items, but could not match its paper profit with free cash flow. Considering all this we'd argue China Isotope & Radiation's profits probably give an overly generous impression of its sustainable level of profitability. If you want to do dive deeper into China Isotope & Radiation, you'd also look into what risks it is currently facing. For example, we've discovered 1 warning sign that you should run your eye over to get a better picture of China Isotope & Radiation.

Our examination of China Isotope & Radiation 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. 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.