Some May Be Optimistic About Landsea Green Life Service's (HKG:1965) Earnings

Investors were disappointed with the weak earnings posted by Landsea Green Life Service Company Limited (HKG:1965 ). Despite the soft profit numbers, our analysis has optimistic about the overall quality of the income statement.

View our latest analysis for Landsea Green Life Service

Examining Cashflow Against Landsea Green Life Service'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. The accrual ratio subtracts the FCF from the profit for a given period, and divides the result by the average operating assets of the company over that time. 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. 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

For the year to June 2023, Landsea Green Life Service had an accrual ratio of -0.68. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. To wit, it produced free cash flow of CN¥145m during the period, dwarfing its reported profit of CN¥19.3m. Notably, Landsea Green Life Service had negative free cash flow last year, so the CN¥145m it produced this year was a welcome improvement. However, that's not all there is to consider. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Landsea Green Life Service.

How Do Unusual Items Influence Profit?

While the accrual ratio might bode well, we also note that Landsea Green Life Service's profit was boosted by unusual items worth CN¥2.3m in the last twelve months. While it's always nice to have higher profit, a large contribution from unusual items sometimes dampens our enthusiasm. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And, after all, that's exactly what the accounting terminology implies. Assuming those unusual items don't show up again in the current year, we'd thus expect profit to be weaker next year (in the absence of business growth, that is).

Our Take On Landsea Green Life Service's Profit Performance

In conclusion, Landsea Green Life Service's accrual ratio suggests its statutory earnings are of good quality, but on the other hand the profits were boosted by unusual items. Considering all the aforementioned, we'd venture that Landsea Green Life Service's profit result is a pretty good guide to its true profitability, albeit a bit on the conservative side. So while earnings quality is important, it's equally important to consider the risks facing Landsea Green Life Service at this point in time. For example, we've found that Landsea Green Life Service has 5 warning signs (2 are a bit unpleasant!) that deserve your attention before going any further with your analysis.

Our examination of Landsea Green Life Service has focussed on certain factors that can make its earnings look better than they are. 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 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.