Dashang Co., Ltd.'s (SHSE:600694) earnings announcement last week didn't impress shareholders. Despite the soft profit numbers, our analysis has optimistic about the overall quality of the income statement.

Zooming In On Dashang'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. 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'.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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.

Dashang has an accrual ratio of -0.27 for the year to December 2023. That indicates that its free cash flow quite significantly exceeded its statutory profit. To wit, it produced free cash flow of CN¥1.6b during the period, dwarfing its reported profit of CN¥505.1m. Dashang shareholders are no doubt pleased that free cash flow improved over the last twelve months.

That might leave you wondering what analysts are forecasting in terms of future profitability. Luckily, you can click here to see an interactive graph depicting future profitability, based on their estimates.

Our Take On Dashang's Profit Performance

Happily for shareholders, Dashang produced plenty of free cash flow to back up its statutory profit numbers. Because of this, we think Dashang's underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! And we are pleased to note that EPS is at least heading in the right direction over the last three years. 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. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. For example - Dashang has 1 warning sign we think you should be aware of.

This note has only looked at a single factor that sheds light on the nature of Dashang'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. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying.

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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.