Why Henan Liliang Diamond's (SZSE:301071) Shaky Earnings Are Just The Beginning Of Its Problems

Last week's earnings announcement from Henan Liliang Diamond Co., Ltd. (SZSE:301071) was disappointing to investors, with a sluggish profit figure. We did some analysis, and found that there are some reasons to be cautious about the headline numbers.

See our latest analysis for Henan Liliang Diamond

Examining Cashflow Against Henan Liliang Diamond'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. This ratio tells us how much of a company's profit is not backed by free cashflow.

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.

For the year to March 2024, Henan Liliang Diamond had an accrual ratio of 0.45. As a general rule, that bodes poorly for future profitability. To wit, the company did not generate one whit of free cashflow in that time. Over the last year it actually had negative free cash flow of CN¥412m, in contrast to the aforementioned profit of CN¥395.2m. We also note that Henan Liliang Diamond's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥412m.

That might leave you wondering what analysts are forecasting in terms of future profitability. Luckily, you can click here to see an interactive graph depicting future profitability, based on their estimates.

Our Take On Henan Liliang Diamond's Profit Performance

As we have made quite clear, we're a bit worried that Henan Liliang Diamond didn't back up the last year's profit with free cashflow. As a result, we think it may well be the case that Henan Liliang Diamond's underlying earnings power is lower than its statutory profit. But on the bright side, its earnings per share have grown at an extremely impressive rate over the last three years. The goal of this article has been to assess how well we can rely on the statutory earnings to reflect the company's potential, but there is plenty more to consider. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. When we did our research, we found 2 warning signs for Henan Liliang Diamond (1 is a bit concerning!) that we believe deserve your full attention.

Today we've zoomed in on a single data point to better understand the nature of Henan Liliang Diamond's profit. 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.