The subdued stock price reaction suggests that Shanghai Yimin Commercial Group Co., Ltd.'s (SHSE:600824) strong earnings didn't offer any surprises. We think that investors have missed some encouraging factors underlying the profit figures.

Examining Cashflow Against Shanghai Yimin Commercial Group'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. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

Therefore, it's actually considered a good thing when a company has a negative accrual ratio, but a bad thing if its accrual ratio is positive. 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. 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 March 2024, Shanghai Yimin Commercial Group had an accrual ratio of -0.16. Therefore, its statutory earnings were very significantly less than its free cashflow. To wit, it produced free cash flow of CN¥264m during the period, dwarfing its reported profit of CN¥51.4m. Shanghai Yimin Commercial Group's free cash flow improved over the last year, which is generally good to see. 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 Shanghai Yimin Commercial Group.

The Impact Of Unusual Items On Profit

Shanghai Yimin Commercial Group's profit was reduced by unusual items worth CN¥7.3m in the last twelve months, and this helped it produce high cash conversion, as reflected by its unusual items. In a scenario where those unusual items included non-cash charges, we'd expect to see a strong accrual ratio, which is exactly what has happened in this case. While deductions due to unusual items are disappointing in the first instance, there is a silver lining. We looked at thousands of listed companies and found that unusual items are very often one-off in nature. And, after all, that's exactly what the accounting terminology implies. Assuming those unusual expenses don't come up again, we'd therefore expect Shanghai Yimin Commercial Group to produce a higher profit next year, all else being equal.

Our Take On Shanghai Yimin Commercial Group's Profit Performance

In conclusion, both Shanghai Yimin Commercial Group's accrual ratio and its unusual items suggest that its statutory earnings are probably reasonably conservative. Based on these factors, we think Shanghai Yimin Commercial Group's earnings potential is at least as good as it seems, and maybe even better! Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. Every company has risks, and we've spotted 1 warning sign for Shanghai Yimin Commercial Group you should know about.

Our examination of Shanghai Yimin Commercial Group 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. 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.