Lesi Group's (HKG:2540) Sluggish Earnings Might Be Just The Beginning Of Its Problems

The market rallied behind Lesi Group Limited's (HKG:2540) stock, leading do a rise in the share price after its recent weak earnings report. Sometimes, shareholders are willing to ignore soft numbers with the hope that they will improve, but our analysis suggests this is unlikely for Lesi Group.

Check out our latest analysis for Lesi Group

Examining Cashflow Against Lesi Group'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. The ratio shows us how much a company's profit exceeds its FCF.

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. 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Lesi Group has an accrual ratio of 0.26 for the year to June 2024. Unfortunately, that means its free cash flow fell significantly short of its reported profits. In the last twelve months it actually had negative free cash flow, with an outflow of CN¥58m despite its profit of CN¥64.1m, mentioned above. We also note that Lesi Group's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥58m.

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

Our Take On Lesi Group's Profit Performance

Lesi Group didn't convert much of its profit to free cash flow in the last year, which some investors may consider rather suboptimal. Because of this, we think that it may be that Lesi Group's statutory profits are better than its underlying earnings power. Nonetheless, it's still worth noting that its earnings per share have grown at 8.2% 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. If you'd like to know more about Lesi Group as a business, it's important to be aware of any risks it's facing. When we did our research, we found 2 warning signs for Lesi Group (1 doesn't sit too well with us!) that we believe deserve your full attention.

This note has only looked at a single factor that sheds light on the nature of Lesi Group's 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. 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 with significant insider holdings 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.