Shanghai Labway Clinical Laboratory Co., Ltd. (SZSE:301060) just reported some strong earnings, and the market rewarded them with a positive share price move. We did some analysis and think that investors are missing some details hidden beneath the profit numbers.

View our latest analysis for Shanghai Labway Clinical Laboratory

A Closer Look At Shanghai Labway Clinical Laboratory'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. 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. 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Shanghai Labway Clinical Laboratory has an accrual ratio of 0.36 for the year to March 2022. Unfortunately, that means its free cash flow was a lot less than its statutory profit, which makes us doubt the utility of profit as a guide. Even though it reported a profit of CN¥327.8m, a look at free cash flow indicates it actually burnt through CN¥51m in the last year. It's worth noting that Shanghai Labway Clinical Laboratory generated positive FCF of CN¥100m a year ago, so at least they've done it in the past.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Shanghai Labway Clinical Laboratory.

Our Take On Shanghai Labway Clinical Laboratory's Profit Performance

As we have made quite clear, we're a bit worried that Shanghai Labway Clinical Laboratory didn't back up the last year's profit with free cashflow. As a result, we think it may well be the case that Shanghai Labway Clinical Laboratory's underlying earnings power is lower than its statutory profit. But on the bright side, its earnings per share have grown at an extremely impressive rate over the last three years. 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. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. To help with this, we've discovered 3 warning signs (1 is a bit concerning!) that you ought to be aware of before buying any shares in Shanghai Labway Clinical Laboratory.

This note has only looked at a single factor that sheds light on the nature of Shanghai Labway Clinical Laboratory's 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.

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.