Despite posting some strong earnings, the market for Dawnrays Pharmaceutical (Holdings) Limited's (HKG:2348) stock hasn't moved much. We did some digging, and we found some concerning factors in the details.
Examining Cashflow Against 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. The accrual ratio subtracts the FCF from the profit for a given period, and divides the result by the average operating assets of the company over that time. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.
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.
For the year to June 2021, Dawnrays Pharmaceutical (Holdings) had an accrual ratio of 0.23. We can therefore deduce that its free cash flow fell well short of covering its statutory profit. To wit, it produced free cash flow of CN¥3.9m during the period, falling well short of its reported profit of CN¥305.1m. Dawnrays Pharmaceutical (Holdings)'s free cash flow actually declined over the last year, but it may bounce back next year, since free cash flow is often more volatile than accounting profits.
Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Dawnrays Pharmaceutical (Holdings).
Our Take On Dawnrays Pharmaceutical (Holdings)'s Profit Performance
Dawnrays Pharmaceutical (Holdings)'s accrual ratio for the last twelve months signifies cash conversion is less than ideal, which is a negative when it comes to our view of its earnings. Because of this, we think that it may be that Dawnrays Pharmaceutical (Holdings)'s statutory profits are better than its underlying earnings power. But at least holders can take some solace from the 33% EPS growth in the 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. So while earnings quality is important, it's equally important to consider the risks facing Dawnrays Pharmaceutical (Holdings) at this point in time. Our analysis shows 4 warning signs for Dawnrays Pharmaceutical (Holdings) (2 are concerning!) and we strongly recommend you look at these before investing.
Today we've zoomed in on a single data point to better understand the nature of Dawnrays Pharmaceutical (Holdings)'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. 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 that insiders are buying 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.
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Dawnrays Pharmaceutical (Holdings)
Dawnrays Pharmaceutical (Holdings) Limited, an investment holding company, develops, manufactures, and sells non-patented pharmaceutical medicines in Mainland China and internationally.
Excellent balance sheet with solid track record.