We Think Liwe Española's (BDM:LIW) Robust Earnings Are Conservative

Liwe Española, S.A.'s (BDM:LIW) strong earnings report was rewarded with a positive stock price move. We have done some analysis, and we found several positive factors beyond the profit numbers.

View our latest analysis for Liwe Española

Zooming In On Liwe Española's Earnings

Many investors haven't heard of the accrual ratio from cashflow, but it is actually a useful measure of how well a company's profit is backed up by free cash flow (FCF) during a given period. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that 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. 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 December 2021, Liwe Española had an accrual ratio of -0.41. Therefore, its statutory earnings were very significantly less than its free cashflow. In fact, it had free cash flow of €34m in the last year, which was a lot more than its statutory profit of €5.30m. Liwe Española shareholders are no doubt pleased that free cash flow improved over the last twelve months. However, that's not all there is to consider. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Liwe Española.

How Do Unusual Items Influence Profit?

Surprisingly, given Liwe Española's accrual ratio implied strong cash conversion, its paper profit was actually boosted by €1.1m in unusual items. While we like to see profit increases, we tend to be a little more cautious when unusual items have made a big contribution. We ran the numbers on most publicly listed companies worldwide, and it's very common for unusual items to be once-off in nature. And, after all, that's exactly what the accounting terminology implies. If Liwe Española doesn't see that contribution repeat, then all else being equal we'd expect its profit to drop over the current year.

Our Take On Liwe Española's Profit Performance

In conclusion, Liwe Española's accrual ratio suggests its statutory earnings are of good quality, but on the other hand the profits were boosted by unusual items. Based on these factors, we think that Liwe Española's profits are a reasonably conservative guide to its underlying profitability. If you'd like to know more about Liwe Española as a business, it's important to be aware of any risks it's facing. For example, we've found that Liwe Española has 4 warning signs (2 are a bit unpleasant!) that deserve your attention before going any further with your analysis.

Our examination of Liwe Española has focussed on certain factors that can make its earnings look better than they are. 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. 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.