The subdued stock price reaction suggests that Shandong Huifa Foodstuff Co.,Ltd.'s (SHSE:603536) strong earnings didn't offer any surprises. Our analysis suggests that investors might be missing some promising details.

Examining Cashflow Against Shandong Huifa FoodstuffLtd'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. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. The ratio shows us how much a company's profit exceeds its FCF.

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 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".

Shandong Huifa FoodstuffLtd has an accrual ratio of -0.16 for the year to March 2024. That indicates that its free cash flow quite significantly exceeded its statutory profit. To wit, it produced free cash flow of CN¥147m during the period, dwarfing its reported profit of CN¥20.0m. Notably, Shandong Huifa FoodstuffLtd had negative free cash flow last year, so the CN¥147m it produced this year was a welcome improvement. Having said that, there is more to the story. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Shandong Huifa FoodstuffLtd.

How Do Unusual Items Influence Profit?

While the accrual ratio might bode well, we also note that Shandong Huifa FoodstuffLtd's profit was boosted by unusual items worth CN¥9.6m in the last twelve months. While we like to see profit increases, we tend to be a little more cautious when unusual items have made a big contribution. We ran the numbers on most publicly listed companies worldwide, and it's very common for unusual items to be once-off in nature. Which is hardly surprising, given the name. Assuming those unusual items don't show up again in the current year, we'd thus expect profit to be weaker next year (in the absence of business growth, that is).

Our Take On Shandong Huifa FoodstuffLtd's Profit Performance

In conclusion, Shandong Huifa FoodstuffLtd's accrual ratio suggests its statutory earnings are of good quality, but on the other hand the profits were boosted by unusual items. Considering the aforementioned, we think that Shandong Huifa FoodstuffLtd's profits are probably a reasonable reflection of its underlying profitability; although we'd be confident in that conclusion if we saw a cleaner set of results. If you want to do dive deeper into Shandong Huifa FoodstuffLtd, you'd also look into what risks it is currently facing. For example, Shandong Huifa FoodstuffLtd has 2 warning signs (and 1 which is concerning) we think you should know about.

Our examination of Shandong Huifa FoodstuffLtd has focussed on certain factors that can make its earnings look better than they are. 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. 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.