Hospital Corporation of China Limited (HKG:3869) recently posted some strong earnings, and the market responded positively. We did some digging and found some further encouraging factors that investors will like.

View our latest analysis for Hospital Corporation of China

Examining Cashflow Against Hospital Corporation of China's Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. 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. The ratio shows us how much a company's profit exceeds its FCF.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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".

For the year to June 2023, Hospital Corporation of China had an accrual ratio of -0.12. Therefore, its statutory earnings were quite a lot less than its free cashflow. To wit, it produced free cash flow of CN¥179m during the period, dwarfing its reported profit of CN¥72.8m. Hospital Corporation of China 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 Hospital Corporation of China.

The Impact Of Unusual Items On Profit

Hospital Corporation of China's profit was reduced by unusual items worth CN¥120m 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. While deductions due to unusual items are disappointing in the first instance, there is a silver lining. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And that's hardly a surprise given these line items are considered unusual. In the twelve months to June 2023, Hospital Corporation of China had a big unusual items expense. All else being equal, this would likely have the effect of making the statutory profit look worse than its underlying earnings power.

Our Take On Hospital Corporation of China's Profit Performance

In conclusion, both Hospital Corporation of China's accrual ratio and its unusual items suggest that its statutory earnings are probably reasonably conservative. Based on these factors, we think Hospital Corporation of China's earnings potential is at least as good as it seems, and maybe even better! If you want to do dive deeper into Hospital Corporation of China, you'd also look into what risks it is currently facing. For example - Hospital Corporation of China has 2 warning signs we think you should be aware of.

Our examination of Hospital Corporation of China has focussed on certain factors that can make its earnings look better than they are. And it has passed with flying colours. But there are plenty of other ways to inform your opinion of a company. 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.

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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.