The latest earnings report from Sanai Health Industry Group Company Limited (HKG:1889 ) disappointed investors. Our analysis suggests that while the headline numbers were soft, there are some positive factors which shareholders may have missed.

Examining Cashflow Against Sanai Health Industry Group'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). In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Over the twelve months to June 2024, Sanai Health Industry Group recorded an accrual ratio of -1.41. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. In fact, it had free cash flow of CN¥162m in the last year, which was a lot more than its statutory profit of CN¥13.1m. Sanai Health Industry Group's free cash flow improved over the last year, which is generally good to see. Having said that, there is more to consider. We must also consider the impact of unusual items on statutory profit (and thus the accrual ratio), as well as note the ramifications of the company issuing new shares.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Sanai Health Industry Group.

One essential aspect of assessing earnings quality is to look at how much a company is diluting shareholders. Sanai Health Industry Group expanded the number of shares on issue by 19% over the last year. That means its earnings are split among a greater number of shares. To celebrate net income while ignoring dilution is like rejoicing because you have a single slice of a larger pizza, but ignoring the fact that the pizza is now cut into many more slices. Check out Sanai Health Industry Group's historical EPS growth by clicking on this link.

How Is Dilution Impacting Sanai Health Industry Group's Earnings Per Share (EPS)?

As you can see above, Sanai Health Industry Group has been growing its net income over the last few years, with an annualized gain of 27% over three years. Net profit actually dropped by 64% in the last year. Unfortunately for shareholders, though, the earnings per share result was even worse, declining 66%. Therefore, the dilution is having a noteworthy influence on shareholder returns.

In the long term, if Sanai Health Industry Group's earnings per share can increase, then the share price should too. However, if its profit increases while its earnings per share stay flat (or even fall) then shareholders might not see much benefit. For that reason, you could say that EPS is more important that net income in the long run, assuming the goal is to assess whether a company's share price might grow.

The Impact Of Unusual Items On Profit

Surprisingly, given Sanai Health Industry Group's accrual ratio implied strong cash conversion, its paper profit was actually boosted by CN¥19m in unusual items. While we like to see profit increases, we tend to be a little more cautious when unusual items have made a big contribution. When we crunched the numbers on thousands of publicly listed companies, we found that a boost from unusual items in a given year is often not repeated the next year. And that's as you'd expect, given these boosts are described as 'unusual'. We can see that Sanai Health Industry Group's positive unusual items were quite significant relative to its profit in the year to June 2024. As a result, we can surmise that the unusual items are making its statutory profit significantly stronger than it would otherwise be.

Our Take On Sanai Health Industry Group's Profit Performance

Summing up, Sanai Health Industry Group's accrual ratio suggests that its statutory earnings are well matched by cash flow while its unusual items boosted the profit in a way that might not be repeated. Further, the dilution means profits are now split more ways. After taking into account all the aforementioned observations we think that Sanai Health Industry Group's profits probably give a generous impression of its sustainable level of profitability. If you want to do dive deeper into Sanai Health Industry Group, you'd also look into what risks it is currently facing. Be aware that Sanai Health Industry Group is showing 6 warning signs in our investment analysis and 2 of those shouldn't be ignored...

Our examination of Sanai Health Industry Group 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 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 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.