Dawnrays Pharmaceutical (Holdings)'s (HKG:2348) Earnings Might Not Be As Promising As They Seem

Following the release of a positive earnings report recently, Dawnrays Pharmaceutical (Holdings) Limited's (HKG:2348) stock performed well. Despite this, we feel that there are some reasons to be cautious with these earnings.

Check out our latest analysis for Dawnrays Pharmaceutical (Holdings)

Zooming In On Dawnrays Pharmaceutical (Holdings)'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. 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'.

That means a negative accrual ratio is a good thing, because it shows that the company is bringing in more free cash flow than its profit would suggest. 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.

For the year to June 2024, Dawnrays Pharmaceutical (Holdings) had an accrual ratio of 0.24. Unfortunately, that means its free cash flow fell significantly short of its reported profits. In fact, it had free cash flow of CN¥125m in the last year, which was a lot less than its statutory profit of CN¥563.1m. At this point we should mention that Dawnrays Pharmaceutical (Holdings) did manage to increase its free cash flow in the last twelve months 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 Dawnrays Pharmaceutical (Holdings).

How Do Unusual Items Influence Profit?

Given the accrual ratio, it's not overly surprising that Dawnrays Pharmaceutical (Holdings)'s profit was boosted by unusual items worth CN¥293m in the last twelve months. We can't deny that higher profits generally leave us optimistic, but we'd prefer it if the profit were to be sustainable. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And that's as you'd expect, given these boosts are described as 'unusual'. We can see that Dawnrays Pharmaceutical (Holdings)'s positive unusual items were quite significant relative to its profit in the year to June 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. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. For example, we've found that Dawnrays Pharmaceutical (Holdings) has 2 warning signs (1 makes us a bit uncomfortable!) that deserve your attention before going any further with your analysis.

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 are plenty of other ways to inform your opinion of a company. 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.