Despite Sinotherapeutics Inc.'s (SHSE:688247) recent earnings report having lackluster headline numbers, the market responded positively. Sometimes, shareholders are willing to ignore soft numbers with the hope that they will improve, but our analysis suggests this is unlikely for Sinotherapeutics.

A Closer Look At Sinotherapeutics' 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. 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. This ratio tells us how much of a company's profit is not backed by free cashflow.

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. 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Sinotherapeutics has an accrual ratio of 0.22 for the year to March 2024. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, which is hardly a good thing. In the last twelve months it actually had negative free cash flow, with an outflow of CN¥19m despite its profit of CN¥76.3m, mentioned above. We also note that Sinotherapeutics' free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥19m.

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 didn't convert much of its profit to free cash flow in the last year, which some investors may consider rather suboptimal. Therefore, it seems possible to us that Sinotherapeutics' true underlying earnings power is actually less than its statutory profit. Sadly, its EPS was down over the last twelve months. 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 Sinotherapeutics, you'd also look into what risks it is currently facing. To help with this, we've discovered 3 warning signs (1 can't be ignored!) that you ought to be aware of before buying any shares in Sinotherapeutics.

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. While it might take a little research on your behalf, you may find this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying to be useful.

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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.