Kingworld Medicines Group Limited's (HKG:1110) healthy profit numbers didn't contain any surprises for investors. However the statutory profit number doesn't tell the whole story, and we have found some factors which might be of concern to shareholders.

See our latest analysis for Kingworld Medicines Group

Examining Cashflow Against Kingworld Medicines Group's Earnings

In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

For the year to June 2022, Kingworld Medicines Group had an accrual ratio of 45.07. Statistically speaking, that's a real negative for future earnings. 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¥33b, in contrast to the aforementioned profit of CN¥35.1m. We also note that Kingworld Medicines Group's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥33b.

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

Our Take On Kingworld Medicines Group's Profit Performance

As we discussed above, we think Kingworld Medicines Group's earnings were not supported by free cash flow, which might concern some investors. For this reason, we think that Kingworld Medicines Group's statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. The good news is that, its earnings per share increased by 65% in the last year. Of course, we've only just scratched the surface when it comes to analysing its earnings; one could also consider margins, forecast growth, and return on investment, among other factors. If you'd like to know more about Kingworld Medicines Group as a business, it's important to be aware of any risks it's facing. To help with this, we've discovered 4 warning signs (2 are a bit concerning!) that you ought to be aware of before buying any shares in Kingworld Medicines Group.

Today we've zoomed in on a single data point to better understand the nature of Kingworld Medicines 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.