We're Not So Sure You Should Rely on Sinco Pharmaceuticals Holdings' (HKG:6833) Statutory Earnings

It might be old fashioned, but we really like to invest in companies that make a profit, each and every year. However, sometimes companies receive a one-off boost (or reduction) to their profit, and it's not always clear whether statutory profits are a good guide, going forward. Today we'll focus on whether this year's statutory profits are a good guide to understanding Sinco Pharmaceuticals Holdings (HKG:6833).

While Sinco Pharmaceuticals Holdings was able to generate revenue of CN¥1.28b in the last twelve months, we think its profit result of CN¥40.1m was more important. The good news is that the company managed to grow its revenue over the last three years, and also move from loss-making to profitable.

View our latest analysis for Sinco Pharmaceuticals Holdings

Of course, it is only sensible to look beyond the statutory profits and question how well those numbers represent the sustainable earnings power of the business. As a result, we think it's well worth considering what Sinco Pharmaceuticals Holdings' cashflow (when compared to its earnings) can tell us about the nature of its statutory profit. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Sinco Pharmaceuticals Holdings.

A Closer Look At Sinco Pharmaceuticals Holdings' 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). In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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

Over the twelve months to June 2020, Sinco Pharmaceuticals Holdings recorded an accrual ratio of 1.14. Statistically speaking, that's a real negative for future earnings. 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¥92m, in contrast to the aforementioned profit of CN¥40.1m. We saw that FCF was CN¥280m a year ago though, so Sinco Pharmaceuticals Holdings has at least been able to generate positive FCF in the past. The good news for shareholders is that Sinco Pharmaceuticals Holdings' accrual ratio was much better last year, so this year's poor reading might simply be a case of a short term mismatch between profit and FCF. As a result, some shareholders may be looking for stronger cash conversion in the current year.

Our Take On Sinco Pharmaceuticals Holdings' Profit Performance

As we discussed above, we think Sinco Pharmaceuticals Holdings' earnings were not supported by free cash flow, which might concern some investors. For this reason, we think that Sinco Pharmaceuticals Holdings' statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. On the bright side, the company showed enough improvement to book a profit this year, after losing money last year. The goal of this article has been to assess how well we can rely on the statutory earnings to reflect the company's potential, but there is plenty more to consider. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. Case in point: We've spotted 3 warning signs for Sinco Pharmaceuticals Holdings you should be mindful of and 2 of these don't sit too well with us.

Today we've zoomed in on a single data point to better understand the nature of Sinco Pharmaceuticals Holdings' profit. But there is always more to discover if you are capable of focussing your mind on minutiae. 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. 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.
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