Sinomax Group Limited's (HKG:1418) solid earnings announcement recently didn't do much to the stock price. We did some digging, and we think that investors are missing some encouraging factors in the underlying numbers.

See our latest analysis for Sinomax Group

Examining Cashflow Against Sinomax Group's Earnings

Many investors haven't heard of the accrual ratio from cashflow, but it is actually a useful measure of how well a company's profit is backed up by free cash flow (FCF) during a given period. 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. 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.

Sinomax Group has an accrual ratio of -0.27 for the year to June 2023. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. In fact, it had free cash flow of HK$364m in the last year, which was a lot more than its statutory profit of HK$24.6m. Sinomax Group shareholders are no doubt pleased that free cash flow improved over the last twelve months. However, that's not all there is to consider. 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 Sinomax Group.

The Impact Of Unusual Items On Profit

Sinomax Group's profit was reduced by unusual items worth HK$1.6m in the last twelve months, and this helped it produce high cash conversion, as reflected by its unusual items. This is what you'd expect to see where a company has a non-cash charge reducing paper profits. It's never great to see unusual items costing the company profits, but on the upside, things might improve sooner rather than later. We looked at thousands of listed companies and found that unusual items are very often one-off in nature. And that's hardly a surprise given these line items are considered unusual. Sinomax Group took a rather significant hit from unusual items in the year to June 2023. As a result, we can surmise that the unusual items made its statutory profit significantly weaker than it would otherwise be.

Our Take On Sinomax Group's Profit Performance

Considering both Sinomax Group's accrual ratio and its unusual items, we think its statutory earnings are unlikely to exaggerate the company's underlying earnings power. Based on these factors, we think Sinomax Group's underlying earnings potential is as good as, or probably even better, than the statutory profit makes it seem! 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. When we did our research, we found 3 warning signs for Sinomax Group (1 shouldn't be ignored!) that we believe deserve your full attention.

After our examination into the nature of Sinomax Group's profit, we've come away optimistic for the company. 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.