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. In this article, we'll look at how useful this year's statutory profit is, when analysing YiChang HEC ChangJiang Pharmaceutical (HKG:1558).
While YiChang HEC ChangJiang Pharmaceutical was able to generate revenue of CN¥5.24b in the last twelve months, we think its profit result of CN¥1.57b was more important. In the chart below, you can see that its profit and revenue have both grown over the last three years.
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. Today, we'll discuss YiChang HEC ChangJiang Pharmaceutical's free cashflow relative to its earnings, and consider what that tells us about the company. That might leave you wondering what analysts are forecasting in terms of future profitability. Luckily, you can click here to see an interactive graph depicting future profitability, based on their estimates.
A Closer Look At YiChang HEC ChangJiang Pharmaceutical'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. 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.
YiChang HEC ChangJiang Pharmaceutical has an accrual ratio of 0.22 for the year to June 2020. Unfortunately, that means its free cash flow fell significantly short of its reported profits. To wit, it produced free cash flow of CN¥574m during the period, falling well short of its reported profit of CN¥1.57b. Given that YiChang HEC ChangJiang Pharmaceutical had negative free cash flow in the prior corresponding period, the trailing twelve month resul of CN¥574m would seem to be a step in the right direction.
Our Take On YiChang HEC ChangJiang Pharmaceutical's Profit Performance
YiChang HEC ChangJiang Pharmaceutical didn't convert much of its profit to free cash flow in the last year, which some investors may consider rather suboptimal. Therefore, it seems possible to us that YiChang HEC ChangJiang Pharmaceutical's true underlying earnings power is actually less than its statutory profit. But the good news is that its EPS growth over the last three years has been very impressive. Of course, we've only just scratched the surface when it comes to analysing its earnings; one could also consider margins, forecast growth, and return on investment, among other factors. If you'd like to know more about YiChang HEC ChangJiang Pharmaceutical as a business, it's important to be aware of any risks it's facing. Our analysis shows 3 warning signs for YiChang HEC ChangJiang Pharmaceutical (1 shouldn't be ignored!) and we strongly recommend you look at these before investing.
This note has only looked at a single factor that sheds light on the nature of YiChang HEC ChangJiang Pharmaceutical's profit. 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.
If you decide to trade YiChang HEC ChangJiang Pharmaceutical, use the lowest-cost* platform that is rated #1 Overall by Barron’s, Interactive Brokers. Trade stocks, options, futures, forex, bonds and funds on 135 markets, all from a single integrated account.
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.
*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.