Dawnrays Pharmaceutical (Holdings)'s (HKG:2348) Earnings Are Built On Soft Foundations

Shareholders didn't seem to be thrilled with Dawnrays Pharmaceutical (Holdings) Limited's (HKG:2348) recent earnings report, despite healthy profit numbers. Our analysis suggests they may be concerned about some underlying details.

We've discovered 2 warning signs about Dawnrays Pharmaceutical (Holdings). View them for free.

Examining Cashflow Against Dawnrays Pharmaceutical (Holdings)'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. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. This ratio tells us how much of a company's profit is not backed by free cashflow.

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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Dawnrays Pharmaceutical (Holdings) has an accrual ratio of 0.29 for the year to December 2024. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, raising questions about how useful that profit figure really is. To wit, it produced free cash flow of CN¥45m during the period, falling well short of its reported profit of CN¥564.9m. Dawnrays Pharmaceutical (Holdings) shareholders will no doubt be hoping that its free cash flow bounces back next year, since it was down 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.

See our latest analysis for Dawnrays Pharmaceutical (Holdings)

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Dawnrays Pharmaceutical (Holdings).

The Impact Of Unusual Items On Profit

The fact that the company had unusual items boosting profit by CN¥289m, in the last year, probably goes some way to explain why its accrual ratio was so weak. 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. We can see that Dawnrays Pharmaceutical (Holdings)'s positive unusual items were quite significant relative to its profit in the year to December 2024. All else being equal, this would likely have the effect of making the statutory profit a poor guide to underlying earnings power.

Our Take On Dawnrays Pharmaceutical (Holdings)'s Profit Performance

Summing up, Dawnrays Pharmaceutical (Holdings) 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 Dawnrays Pharmaceutical (Holdings)'s profits probably give an overly generous impression of its sustainable level of profitability. If you want to do dive deeper into Dawnrays Pharmaceutical (Holdings), you'd also look into what risks it is currently facing. For instance, we've identified 2 warning signs for Dawnrays Pharmaceutical (Holdings) (1 is a bit unpleasant) you should be familiar with.

In this article we've looked at a number of factors that can impair the utility of profit numbers, and we've come away cautious. 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. While it might take a little research on your behalf, you may find this free collection of companies boasting high return on equity, or this list of stocks with significant insider holdings to be useful.

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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.