Beijing Foyou Pharma CO.,LTD (SHSE:601089) announced strong profits, but the stock was stagnant. Our analysis suggests that shareholders have noticed something concerning in the numbers.
Examining Cashflow Against Beijing Foyou PharmaLTD's Earnings
One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. 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.
As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".
For the year to December 2023, Beijing Foyou PharmaLTD had an accrual ratio of 0.35. We can therefore deduce that its free cash flow fell well short of covering its statutory profit, suggesting we might want to think twice before putting a lot of weight on the latter. To wit, it produced free cash flow of CN¥190m during the period, falling well short of its reported profit of CN¥488.8m. Beijing Foyou PharmaLTD shareholders will no doubt be hoping that its free cash flow bounces back next year, since it was down over the last twelve months. The good news for shareholders is that Beijing Foyou PharmaLTD'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.
Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Beijing Foyou PharmaLTD.
Our Take On Beijing Foyou PharmaLTD's Profit Performance
As we discussed above, we think Beijing Foyou PharmaLTD's earnings were not supported by free cash flow, which might concern some investors. For this reason, we think that Beijing Foyou PharmaLTD's statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. Nonetheless, it's still worth noting that its earnings per share have grown at 40% over the last three years. 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. If you want to do dive deeper into Beijing Foyou PharmaLTD, you'd also look into what risks it is currently facing. For example, Beijing Foyou PharmaLTD has 2 warning signs (and 1 which shouldn't be ignored) we think you should know about.
This note has only looked at a single factor that sheds light on the nature of Beijing Foyou PharmaLTD's profit. But there is always more to discover if you are capable of focussing your mind on minutiae. 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 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.