Extrawell Pharmaceutical Holdings (HKG:858) Shareholders Should Be Cautious Despite Solid Earnings

Extrawell Pharmaceutical Holdings Limited (HKG:858) posted some decent earnings, but shareholders didn't react strongly. Our analysis suggests they may be concerned about some underlying details.

View our latest analysis for Extrawell Pharmaceutical Holdings

Zooming In On Extrawell Pharmaceutical Holdings' Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. 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. 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Over the twelve months to September 2024, Extrawell Pharmaceutical Holdings recorded 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 HK$1.6m during the period, falling well short of its reported profit of HK$175.7m. Given that Extrawell Pharmaceutical Holdings had negative free cash flow in the prior corresponding period, the trailing twelve month resul of HK$1.6m 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. The good news for shareholders is that Extrawell Pharmaceutical Holdings' accrual ratio was much better last year, so this year's poor reading might simply be a case of a short term mismatch between profit and FCF. Shareholders should look for improved cashflow relative to profit in the current year, if that is indeed the case.

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

The Impact Of Unusual Items On Profit

The fact that the company had unusual items boosting profit by HK$204m, in the last year, probably goes some way to explain why its accrual ratio was so weak. While we like to see profit increases, we tend to be a little more cautious when unusual items have made a big contribution. 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. Extrawell Pharmaceutical Holdings had a rather significant contribution from unusual items relative to its profit to September 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 Extrawell Pharmaceutical Holdings' Profit Performance

Extrawell Pharmaceutical Holdings had a weak accrual ratio, but its profit did receive a boost from unusual items. For the reasons mentioned above, we think that a perfunctory glance at Extrawell Pharmaceutical Holdings' statutory profits might make it look better than it really is on an underlying level. If you'd like to know more about Extrawell Pharmaceutical Holdings as a business, it's important to be aware of any risks it's facing. Every company has risks, and we've spotted 4 warning signs for Extrawell Pharmaceutical Holdings (of which 3 can't be ignored!) you should know about.

Our examination of Extrawell Pharmaceutical Holdings has focussed on certain factors that can make its earnings look better than they are. And, on that basis, we are somewhat skeptical. 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. 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.