We Think That There Are More Issues For Luoyang Glass (HKG:1108) Than Just Sluggish Earnings

A lackluster earnings announcement from Luoyang Glass Company Limited (HKG:1108) last week didn't sink the stock price. However, we believe that investors should be aware of some underlying factors which may be of concern.

View our latest analysis for Luoyang Glass

Zooming In On Luoyang Glass' 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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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. 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".

Luoyang Glass has an accrual ratio of 0.42 for the year to June 2022. Statistically speaking, that's a real negative for future earnings. 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¥1.8b, in contrast to the aforementioned profit of CN¥305.6m. We saw that FCF was CN¥73m a year ago though, so Luoyang Glass has at least been able to generate positive FCF in the past.

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 Luoyang Glass' Profit Performance

As we have made quite clear, we're a bit worried that Luoyang Glass didn't back up the last year's profit with free cashflow. For this reason, we think that Luoyang Glass' 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. 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. For instance, we've identified 3 warning signs for Luoyang Glass (1 doesn't sit too well with us) you should be familiar with.

Today we've zoomed in on a single data point to better understand the nature of Luoyang Glass' profit. But there is always more to discover if you are capable of focussing your mind on minutiae. Some people consider a high return on equity to be a good sign of a quality business. 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.