We believe that Changmao Biochemical Engineering (HKG:954) revenues are a poor guide to its profitability

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Although Changmao Biochemical Engineering Company Limited (HKG:954) posted strong earnings recently, the stock has not reacted much. We decided to deepen our analysis and we believe that investors might be concerned about several worrying factors that we have discovered.

Check out our latest analysis for Changmao Biochemical Engineering

SEHK: 954 Earnings & Revenue History April 28, 2022

Focus on the profits of Changmao Biochemical Engineering

A key financial ratio used to measure a company’s ability to convert earnings into free cash flow (FCF) is the exercise ratio. The strike 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 period. The ratio shows us how much a company’s profit exceeds its FCF.

Therefore, a negative accrual ratio is positive for the company and a positive accrual ratio is negative. That’s not to say we should worry about a positive accumulation ratio, but it’s worth noting where the accumulation ratio is rather high. Notably, there is academic evidence that suggests a high exercise ratio is a bad sign for short-term profits, generally speaking.

Changmao Biochemical Engineering has an accrual ratio of 0.39 for the year to December 2021. Statistically speaking, this is a real negative for future earnings. And indeed, during the period, the company produced no free cash flow. In the last year he had actually negative free cash flow of 184 million Canadian yen, in contrast to the aforementioned profit of 58.3 million domestic yen. We also note that Changmao Biochemical Engineering’s free cash flow was also negative last year, so we could understand if shareholders were bothered by its 184 million yen outflow. However, that’s not all there is to consider. The adjustment rate reflects the impact of unusual items on the statutory profit, at least in part.

To note: we always recommend that investors check the strength of the balance sheet. Click here to access our analysis of Changmao Biochemical Engineering’s balance sheet.

How do unusual items affect profits?

The fact that the company had unusual items boosting its earnings by 125 million Canadian yen last year is likely part of the reason why its accrual rate was so low. We can’t deny that higher earnings generally leave us optimistic, but we would prefer earnings to be sustainable. We have analyzed the figures of most publicly traded companies around the world, and it is very common for unusual items to be unique in nature. And that’s as you’d expect, given that these boosts are described as “unusual.” Changmao Biochemical Engineering had a fairly large contribution of unusual items to its earnings through December 2021. All other things being equal, this would likely have the effect of making statutory earnings a poor indicator of underdeveloped earnings power. underlying.

Our view on the earnings performance of Changmao Biochemical Engineering

In summary, Changmao Biochemical Engineering received a good boost to profit from unusual items, but could not match its paper earnings with free cash flow. Considering all of this, we would say that Changmao Biochemical Engineering’s earnings probably give too generous an impression of its level of sustainable profitability. So, while the quality of the benefits is important, it is equally important to consider the risks that Changmao Biochemical Engineering currently faces. To help you, we found 2 warning signs (1 is significant!) you need to know before buying shares of Changmao Biochemical Engineering.

Our Changmao Biochemical Engineering review has focused on some factors that can make its profits look better than they are. And, based on that, we’re somewhat skeptical. But there are many other ways to inform your opinion about a company. Some people consider a high return on equity to be a good sign of a quality company. Although it might take a bit of research on your behalf, you might find this free collection of companies offering a high return on equity, or this list of stocks that insiders buy to be useful.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.

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