Sinotherapeutics Inc. (SHSE:688247) just released a solid earnings report, and the stock displayed some strength. However, we think that shareholders should be cautious as we found some worrying factors underlying the profit.

A Closer Look At Sinotherapeutics' Earnings

As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. 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'.

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. That is not intended to imply we should worry about a positive accrual ratio, but it's worth noting where the accrual ratio is rather high. 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 September 2024, Sinotherapeutics had an accrual ratio of 0.23. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, which is hardly a good thing. Indeed, in the last twelve months it reported free cash flow of CN¥4.9m, which is significantly less than its profit of CN¥109.6m. Notably, Sinotherapeutics had negative free cash flow last year, so the CN¥4.9m it produced this year was a welcome improvement.

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

Our Take On Sinotherapeutics' Profit Performance

Sinotherapeutics' accrual ratio for the last twelve months signifies cash conversion is less than ideal, which is a negative when it comes to our view of its earnings. Because of this, we think that it may be that Sinotherapeutics' statutory profits are better than its underlying earnings power. The good news is that, its earnings per share increased by 46% in the last year. The goal of this article has been to assess how well we can rely on the statutory earnings to reflect the company's potential, but there is plenty more to consider. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. While conducting our analysis, we found that Sinotherapeutics has 1 warning sign and it would be unwise to ignore it.

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