Sanai Health Industry Group Company Limited (HKG:1889) 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.

Check out our latest analysis for Sanai Health Industry Group

A Closer Look At Sanai Health Industry Group's 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. The accrual ratio subtracts the FCF from the profit for a given period, and divides the result by the average operating assets of the company over that time. The ratio shows us how much a company's profit exceeds its FCF.

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

Over the twelve months to June 2022, Sanai Health Industry Group recorded an accrual ratio of 0.95. As a general rule, that bodes poorly for future profitability. And indeed, during the period the company didn't produce any free cash flow whatsoever. Over the last year it actually had negative free cash flow of CN¥128m, in contrast to the aforementioned profit of CN¥10.8m. It's worth noting that Sanai Health Industry Group generated positive FCF of CN¥125m a year ago, so at least they've done it in the past. One positive for Sanai Health Industry Group shareholders is that it's accrual ratio was significantly better last year, providing reason to believe that it may return to stronger cash conversion in the future. Shareholders should look for improved cashflow relative to profit in the current year, if that is indeed the case.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Sanai Health Industry Group.

Our Take On Sanai Health Industry Group's Profit Performance

As we have made quite clear, we're a bit worried that Sanai Health Industry Group didn't back up the last year's profit with free cashflow. As a result, we think it may well be the case that Sanai Health Industry Group's underlying earnings power is lower than its statutory profit. The good news is that, its earnings per share increased by 5.2% in the last year. At the end of the day, it's essential to consider more than just the factors above, if you want to understand the company properly. In light of this, if you'd like to do more analysis on the company, it's vital to be informed of the risks involved. To help with this, we've discovered 3 warning signs (1 is concerning!) that you ought to be aware of before buying any shares in Sanai Health Industry Group.

This note has only looked at a single factor that sheds light on the nature of Sanai Health Industry Group'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.