The market for Guangdong Jiaying Pharmaceutical Co., Ltd's (SZSE:002198) shares didn't move much after it posted weak earnings recently. We did some digging, and we believe the earnings are stronger than they seem.

A Closer Look At Guangdong Jiaying Pharmaceutical'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.

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 it's not a problem to have a positive accrual ratio, indicating a certain level of non-cash profits, a high accrual ratio is arguably a bad thing, because it indicates paper profits are not matched by cash flow. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

For the year to March 2024, Guangdong Jiaying Pharmaceutical had an accrual ratio of -0.15. Therefore, its statutory earnings were very significantly less than its free cashflow. Indeed, in the last twelve months it reported free cash flow of CN¥100m, well over the CN¥27.3m it reported in profit. Guangdong Jiaying Pharmaceutical's free cash flow improved over the last year, which is generally good to see.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Guangdong Jiaying Pharmaceutical.

Our Take On Guangdong Jiaying Pharmaceutical's Profit Performance

As we discussed above, Guangdong Jiaying Pharmaceutical has perfectly satisfactory free cash flow relative to profit. Based on this observation, we consider it likely that Guangdong Jiaying Pharmaceutical's statutory profit actually understates its earnings potential! Unfortunately, though, its earnings per share actually fell back over the last year. Of course, we've only just scratched the surface when it comes to analysing its earnings; one could also consider margins, forecast growth, and return on investment, among other factors. If you'd like to know more about Guangdong Jiaying Pharmaceutical as a business, it's important to be aware of any risks it's facing. You'd be interested to know, that we found 1 warning sign for Guangdong Jiaying Pharmaceutical and you'll want to know about it.

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