The market shrugged off the recent earnings report from China Biotech Services Holdings Limited (HKG:8037), despite the profit numbers being soft. We think that investors might be looking at some positive factors beyond the earnings numbers.

Check out our latest analysis for China Biotech Services Holdings

Examining Cashflow Against China Biotech Services Holdings' 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'.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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".

For the year to June 2022, China Biotech Services Holdings had an accrual ratio of -0.41. Therefore, its statutory earnings were very significantly less than its free cashflow. Indeed, in the last twelve months it reported free cash flow of HK$222m, well over the HK$63.4m it reported in profit. China Biotech Services Holdings' free cash flow actually declined over the last year, which is disappointing, like non-biodegradable balloons.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of China Biotech Services Holdings.

Our Take On China Biotech Services Holdings' Profit Performance

As we discussed above, China Biotech Services Holdings' accrual ratio indicates strong conversion of profit to free cash flow, which is a positive for the company. Based on this observation, we consider it possible that China Biotech Services Holdings' statutory profit actually understates its earnings potential! Unfortunately, though, its earnings per share actually fell back over 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. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. You'd be interested to know, that we found 1 warning sign for China Biotech Services Holdings and you'll want to know about it.

This note has only looked at a single factor that sheds light on the nature of China Biotech Services Holdings' 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. 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.