Last week's profit announcement from Tiande Chemical Holdings Limited (HKG:609) was underwhelming for investors, despite headline numbers being robust. Our analysis uncovered some concerning factors that we believe the market might be paying attention to.

View our latest analysis for Tiande Chemical Holdings

A Closer Look At Tiande Chemical Holdings' 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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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 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".

Over the twelve months to December 2021, Tiande Chemical Holdings recorded an accrual ratio of 0.20. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, which is hardly a good thing. Indeed, in the last twelve months it reported free cash flow of CN¥61m, which is significantly less than its profit of CN¥379.6m. Given that Tiande Chemical Holdings had negative free cash flow in the prior corresponding period, the trailing twelve month resul of CN¥61m would seem to be a step in the right direction.

That might leave you wondering what analysts are forecasting in terms of future profitability. Luckily, you can click here to see an interactive graph depicting future profitability, based on their estimates.

Our Take On Tiande Chemical Holdings' Profit Performance

Tiande Chemical Holdings' accrual ratio for the last twelve months signifies cash conversion is less than ideal, which is a negative when it comes to our view of its earnings. Because of this, we think that it may be that Tiande Chemical Holdings' statutory profits are better than its underlying earnings power. But the happy news is that, while acknowledging we have to look beyond the statutory numbers, those numbers are still improving, with EPS growing at a very high rate over 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. So while earnings quality is important, it's equally important to consider the risks facing Tiande Chemical Holdings at this point in time. For example, Tiande Chemical Holdings has 3 warning signs (and 1 which shouldn't be ignored) we think you should know about.

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

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.