China Lilang's (HKG:1234) Earnings Offer More Than Meets The Eye

China Lilang Limited (HKG:1234) announced a healthy earnings result recently, and the market rewarded it with a strong uplift in the stock price. This reaction by the market reaction is understandable when looking at headline profits and we have found some further encouraging factors.

See our latest analysis for China Lilang

Examining Cashflow Against China Lilang's Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. 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. This ratio tells us how much of a company's profit is not backed by free cashflow.

Therefore, it's actually considered a good thing when a company has a negative accrual ratio, but a bad thing if its accrual ratio is positive. 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

For the year to December 2023, China Lilang had an accrual ratio of -0.12. That indicates that its free cash flow was a fair bit more than its statutory profit. In fact, it had free cash flow of CN¥967m in the last year, which was a lot more than its statutory profit of CN¥530.4m. China Lilang's free cash flow improved over the last year, which is generally good to see.

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 China Lilang's Profit Performance

China Lilang's accrual ratio is solid, and indicates strong free cash flow, as we discussed, above. Based on this observation, we consider it likely that China Lilang's statutory profit actually understates its earnings potential! And on top of that, its earnings per share increased by 18% in the last year. 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. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. While conducting our analysis, we found that China Lilang has 1 warning sign and it would be unwise to ignore this.

This note has only looked at a single factor that sheds light on the nature of China Lilang'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. 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.