We Think You Can Look Beyond Zhongzhi Pharmaceutical Holdings' (HKG:3737) Lackluster Earnings

The most recent earnings report from Zhongzhi Pharmaceutical Holdings Limited (HKG:3737) was disappointing for shareholders. Despite the soft profit numbers, our analysis has optimistic about the overall quality of the income statement.

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Zooming In On Zhongzhi Pharmaceutical 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). 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. 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. While having an accrual ratio above zero is of little concern, we do think it's worth noting when a company has a relatively high accrual ratio. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Over the twelve months to June 2025, Zhongzhi Pharmaceutical Holdings recorded an accrual ratio of -0.11. That implies it has good cash conversion, and implies that its free cash flow solidly exceeded its profit last year. To wit, it produced free cash flow of CN¥123m during the period, dwarfing its reported profit of CN¥20.6m. Given that Zhongzhi Pharmaceutical Holdings had negative free cash flow in the prior corresponding period, the trailing twelve month resul of CN¥123m would seem to be a step in the right direction. However, that's not all there is to consider. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part.

Check out our latest analysis for Zhongzhi Pharmaceutical Holdings

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

How Do Unusual Items Influence Profit?

Zhongzhi Pharmaceutical Holdings' profit was reduced by unusual items worth CN¥7.9m in the last twelve months, and this helped it produce high cash conversion, as reflected by its unusual items. This is what you'd expect to see where a company has a non-cash charge reducing paper profits. While deductions due to unusual items are disappointing in the first instance, there is a silver lining. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And, after all, that's exactly what the accounting terminology implies. If Zhongzhi Pharmaceutical Holdings doesn't see those unusual expenses repeat, then all else being equal we'd expect its profit to increase over the coming year.

Our Take On Zhongzhi Pharmaceutical Holdings' Profit Performance

In conclusion, both Zhongzhi Pharmaceutical Holdings' accrual ratio and its unusual items suggest that its statutory earnings are probably reasonably conservative. Based on these factors, we think Zhongzhi Pharmaceutical Holdings' earnings potential is at least as good as it seems, and maybe even better! With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. For instance, we've identified 4 warning signs for Zhongzhi Pharmaceutical Holdings (1 is a bit concerning) you should be familiar with.

Our examination of Zhongzhi Pharmaceutical Holdings has focussed on certain factors that can make its earnings look better than they are. And it has passed with flying colours. 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 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.