Shaanxi Meibang Pharmaceutical Group Co., Ltd. (SHSE:605033) announced strong profits, but the stock was stagnant. Our analysis suggests that shareholders have noticed something concerning in the numbers.

Check out our latest analysis for Shaanxi Meibang Pharmaceutical Group

Zooming In On Shaanxi Meibang Pharmaceutical 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. 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.

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. 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 December 2021, Shaanxi Meibang Pharmaceutical Group had an accrual ratio of 0.81. As a general rule, that bodes poorly for future profitability. And indeed, during the period the company didn't produce any free cash flow whatsoever. Over the last year it actually had negative free cash flow of CN¥215m, in contrast to the aforementioned profit of CN¥125.7m. We saw that FCF was CN¥13m a year ago though, so Shaanxi Meibang Pharmaceutical Group has at least been able to generate positive FCF in the past.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Shaanxi Meibang Pharmaceutical Group.

Our Take On Shaanxi Meibang Pharmaceutical Group's Profit Performance

As we have made quite clear, we're a bit worried that Shaanxi Meibang Pharmaceutical Group didn't back up the last year's profit with free cashflow. For this reason, we think that Shaanxi Meibang Pharmaceutical Group's statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. But the good news is that its EPS growth over the last three years has been very impressive. 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 Shaanxi Meibang Pharmaceutical Group at this point in time. While conducting our analysis, we found that Shaanxi Meibang Pharmaceutical Group has 1 warning sign and it would be unwise to ignore it.

Today we've zoomed in on a single data point to better understand the nature of Shaanxi Meibang Pharmaceutical Group's profit. But there is always more to discover if you are capable of focussing your mind on minutiae. 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.

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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.