We're Not So Sure You Should Rely on Zhongchao's (NASDAQ:ZCMD) Statutory Earnings

Statistically speaking, it is less risky to invest in profitable companies than in unprofitable ones. Having said that, sometimes statutory profit levels are not a good guide to ongoing profitability, because some short term one-off factor has impacted profit levels. This article will consider whether Zhongchao's (NASDAQ:ZCMD) statutory profits are a good guide to its underlying earnings.

While Zhongchao was able to generate revenue of US$16.4m in the last twelve months, we think its profit result of US$3.77m was more important.

See our latest analysis for Zhongchao

Of course, when it comes to statutory profit, the devil is often in the detail, and we can get a better sense for a company by diving deeper into the financial statements. So today we'll look at what Zhongchao's cashflow tells us about the quality of its earnings. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Zhongchao.

Zooming In On Zhongchao's Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. To get the accrual ratio we first subtract FCF from profit for a period, and then divide that number by the average operating assets for the period. The ratio shows us how much a company's profit exceeds its FCF.

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 it's not a problem to have a positive accrual ratio, indicating a certain level of non-cash profits, a high accrual ratio is arguably a bad thing, because it indicates paper profits are not matched by cash flow. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Zhongchao has an accrual ratio of 0.47 for the year to June 2020. As a general rule, that bodes poorly for future profitability. To wit, the company did not generate one whit of free cashflow in that time. In the last twelve months it actually had negative free cash flow, with an outflow of US$292k despite its profit of US$3.77m, mentioned above. We also note that Zhongchao's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of US$292k.

Our Take On Zhongchao's Profit Performance

As we discussed above, we think Zhongchao's earnings were not supported by free cash flow, which might concern some investors. As a result, we think it may well be the case that Zhongchao's underlying earnings power is lower than its statutory profit. Sadly, its EPS was down over the last twelve months. At the end of the day, it's essential to consider more than just the factors above, if you want to understand the company properly. If you'd like to know more about Zhongchao as a business, it's important to be aware of any risks it's facing. Every company has risks, and we've spotted 2 warning signs for Zhongchao (of which 1 is significant!) you should know about.

This note has only looked at a single factor that sheds light on the nature of Zhongchao's profit. But there is always more to discover if you are capable of focussing your mind on minutiae. 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. 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. 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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