Despite posting some strong earnings, the market for Shan Dong Lu Bei Chemical Co.,Ltd's (SHSE:600727) stock hasn't moved much. We did some digging, and we found some concerning factors in the details.

Examining Cashflow Against Shan Dong Lu Bei ChemicalLtd'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. This ratio tells us how much of a company's profit is not backed by free cashflow.

That means a negative accrual ratio is a good thing, because it shows that the company is bringing in more free cash flow than its profit would suggest. 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.

For the year to June 2024, Shan Dong Lu Bei ChemicalLtd had an accrual ratio of 0.22. Unfortunately, that means its free cash flow fell significantly short of its reported profits. Even though it reported a profit of CN¥235.3m, a look at free cash flow indicates it actually burnt through CN¥320m in the last year. It's worth noting that Shan Dong Lu Bei ChemicalLtd generated positive FCF of CN¥269m a year ago, so at least they've done it in the past. The good news for shareholders is that Shan Dong Lu Bei ChemicalLtd's 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. As a result, some shareholders may be looking for stronger cash conversion in the current year.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Shan Dong Lu Bei ChemicalLtd.

Our Take On Shan Dong Lu Bei ChemicalLtd's Profit Performance

Shan Dong Lu Bei ChemicalLtd didn't convert much of its profit to free cash flow in the last year, which some investors may consider rather suboptimal. Therefore, it seems possible to us that Shan Dong Lu Bei ChemicalLtd's true underlying earnings power is actually less than its statutory profit. On the bright side, the company showed enough improvement to book a profit this year, after losing money last year. 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 want to do dive deeper into Shan Dong Lu Bei ChemicalLtd, you'd also look into what risks it is currently facing. To help with this, we've discovered 3 warning signs (2 are potentially serious!) that you ought to be aware of before buying any shares in Shan Dong Lu Bei ChemicalLtd.

Today we've zoomed in on a single data point to better understand the nature of Shan Dong Lu Bei ChemicalLtd's profit. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.