Zhangzhou Pientzehuang Pharmaceutical., Ltd's (SHSE:600436) healthy profit numbers didn't contain any surprises for investors. We believe that shareholders have noticed some concerning factors beyond the statutory profit numbers.

A Closer Look At Zhangzhou Pientzehuang Pharmaceutical's Earnings

In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). 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'.

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, Zhangzhou Pientzehuang Pharmaceutical had an accrual ratio of 0.38. Ergo, its free cash flow is significantly weaker than its profit. Statistically speaking, that's a real negative for future earnings. In fact, it had free cash flow of CN¥1.1b in the last year, which was a lot less than its statutory profit of CN¥2.98b. Zhangzhou Pientzehuang Pharmaceutical's free cash flow actually declined over the last year, but it may bounce back next year, since free cash flow is often more volatile than accounting profits. The good news for shareholders is that Zhangzhou Pientzehuang Pharmaceutical'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.

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 Zhangzhou Pientzehuang Pharmaceutical's Profit Performance

As we have made quite clear, we're a bit worried that Zhangzhou Pientzehuang Pharmaceutical didn't back up the last year's profit with free cashflow. As a result, we think it may well be the case that Zhangzhou Pientzehuang Pharmaceutical's underlying earnings power is lower than its statutory profit. But at least holders can take some solace from the 55% per annum growth in EPS for the last three. 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 Zhangzhou Pientzehuang Pharmaceutical, you'd also look into what risks it is currently facing. When we did our research, we found 2 warning signs for Zhangzhou Pientzehuang Pharmaceutical (1 is concerning!) that we believe deserve your full attention.

This note has only looked at a single factor that sheds light on the nature of Zhangzhou Pientzehuang Pharmaceutical'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.

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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.