We Think You Can Look Beyond Guangdong Kanghua Healthcare Group's (HKG:3689) Lackluster Earnings

Soft earnings didn't appear to concern Guangdong Kanghua Healthcare Group Co., Ltd.'s (HKG:3689) shareholders over the last week. We did some digging, and we believe the earnings are stronger than they seem.

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A Closer Look At Guangdong Kanghua Healthcare 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. This ratio tells us how much of a company's profit is not backed by free cashflow.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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 2024, Guangdong Kanghua Healthcare Group had an accrual ratio of -0.17. Therefore, its statutory earnings were very significantly less than its free cashflow. In fact, it had free cash flow of CN¥193m in the last year, which was a lot more than its statutory profit of CN¥15.3m. Guangdong Kanghua Healthcare 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.

View our latest analysis for Guangdong Kanghua Healthcare Group

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Guangdong Kanghua Healthcare Group.

The Impact Of Unusual Items On Profit

Guangdong Kanghua Healthcare Group's profit was reduced by unusual items worth CN¥9.8m in the last twelve months, and this helped it produce high cash conversion, as reflected by its unusual items. This is what you'd expect to see where a company has a non-cash charge reducing paper profits. While deductions due to unusual items are disappointing in the first instance, there is a silver lining. We looked at thousands of listed companies and found that unusual items are very often one-off in nature. And, after all, that's exactly what the accounting terminology implies. Assuming those unusual expenses don't come up again, we'd therefore expect Guangdong Kanghua Healthcare Group to produce a higher profit next year, all else being equal.

Our Take On Guangdong Kanghua Healthcare Group's Profit Performance

Considering both Guangdong Kanghua Healthcare Group's accrual ratio and its unusual items, we think its statutory earnings are unlikely to exaggerate the company's underlying earnings power. Looking at all these factors, we'd say that Guangdong Kanghua Healthcare Group's underlying earnings power is at least as good as the statutory numbers would make it seem. If you'd like to know more about Guangdong Kanghua Healthcare Group as a business, it's important to be aware of any risks it's facing. At Simply Wall St, we found 3 warning signs for Guangdong Kanghua Healthcare Group and we think they deserve your attention.

Our examination of Guangdong Kanghua Healthcare Group has focussed on certain factors that can make its earnings look better than they are. And it has passed with flying colours. 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 with high insider ownership.

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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.