A lackluster earnings announcement from Jilin Province Xidian Pharmaceutical Sci-Tech Development Co.,Ltd (SZSE:301130) last week didn't sink the stock price. However, we believe that investors should be aware of some underlying factors which may be of concern.

A Closer Look At Jilin Province Xidian Pharmaceutical Sci-Tech DevelopmentLtd's Earnings

Many investors haven't heard of the accrual ratio from cashflow, but it is actually a useful measure of how well a company's profit is backed up by free cash flow (FCF) during a given period. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that 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 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Jilin Province Xidian Pharmaceutical Sci-Tech DevelopmentLtd has an accrual ratio of 0.33 for the year to June 2024. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, raising questions about how useful that profit figure really is. Over the last year it actually had negative free cash flow of CN¥95m, in contrast to the aforementioned profit of CN¥44.6m. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of CN¥95m, this year, indicates high risk. 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 Jilin Province Xidian Pharmaceutical Sci-Tech DevelopmentLtd.

How Do Unusual Items Influence Profit?

Given the accrual ratio, it's not overly surprising that Jilin Province Xidian Pharmaceutical Sci-Tech DevelopmentLtd's profit was boosted by unusual items worth CN¥4.7m in the last twelve months. While it's always nice to have higher profit, a large contribution from unusual items sometimes dampens our enthusiasm. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. Which is hardly surprising, given the name. If Jilin Province Xidian Pharmaceutical Sci-Tech DevelopmentLtd doesn't see that contribution repeat, then all else being equal we'd expect its profit to drop over the current year.

Our Take On Jilin Province Xidian Pharmaceutical Sci-Tech DevelopmentLtd's Profit Performance

Summing up, Jilin Province Xidian Pharmaceutical Sci-Tech DevelopmentLtd 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 Jilin Province Xidian Pharmaceutical Sci-Tech DevelopmentLtd's profits probably give an overly generous impression of its sustainable level of profitability. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. For example, Jilin Province Xidian Pharmaceutical Sci-Tech DevelopmentLtd has 3 warning signs (and 2 which are concerning) we think you should know about.

Our examination of Jilin Province Xidian Pharmaceutical Sci-Tech DevelopmentLtd 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 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.