As a general rule, we think profitable companies are less risky than companies that lose money. Having said that, sometimes statutory profit levels are not a good guide to ongoing profitability, because some short term one-off factor has impacted profit levels. In this article, we’ll look at how useful this year’s statutory profit is, when analysing Beijing Chunlizhengda Medical Instruments (HKG:1858).
We like the fact that Beijing Chunlizhengda Medical Instruments made a profit of CN¥244.4m on its revenue of CN¥887.3m, in the last year. One positive is that it has grown both its profit and its revenue, over the last few years.
Importantly, statutory profits are not always the best tool for understanding a company’s true earnings power, so it’s well worth examining profits in a little more detail. So today we’ll look at what Beijing Chunlizhengda Medical Instruments’ cashflow tells us about the quality of its earnings. 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.
Examining Cashflow Against Beijing Chunlizhengda Medical Instruments’ 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. To get the accrual ratio we first subtract FCF from profit for a period, and then divide that number by the average operating assets for the 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. 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 2020, Beijing Chunlizhengda Medical Instruments had an accrual ratio of 0.36. Ergo, its free cash flow is significantly weaker than its profit. As a general rule, that bodes poorly for future profitability. Indeed, in the last twelve months it reported free cash flow of CN¥109m, which is significantly less than its profit of CN¥244.4m. At this point we should mention that Beijing Chunlizhengda Medical Instruments did manage to increase its free cash flow in the last twelve months
Our Take On Beijing Chunlizhengda Medical Instruments’ Profit Performance
As we discussed above, we think Beijing Chunlizhengda Medical Instruments’ earnings were not supported by free cash flow, which might concern some investors. For this reason, we think that Beijing Chunlizhengda Medical Instruments’ statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. But the good news is that its EPS growth over the last three years has been very impressive. 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 want to do dive deeper into Beijing Chunlizhengda Medical Instruments, you’d also look into what risks it is currently facing. When we did our research, we found 2 warning signs for Beijing Chunlizhengda Medical Instruments (1 is concerning!) that we believe deserve your full attention.
Today we’ve zoomed in on a single data point to better understand the nature of Beijing Chunlizhengda Medical Instruments’ profit. But there are plenty of other ways to inform your opinion of a company. 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. 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.
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