Lushang Life Services' (HKG:2376) Anemic Earnings Might Be Worse Than You Think

A lackluster earnings announcement from Lushang Life Services Co., Ltd. (HKG:2376) last week didn't sink the stock price. Our analysis suggests that along with soft profit numbers, investors should be aware of some other underlying weaknesses in the numbers.

See our latest analysis for Lushang Life Services

Examining Cashflow Against Lushang Life Services' Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. 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. 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.

Lushang Life Services has an accrual ratio of 0.55 for the year to December 2023. As a general rule, that bodes poorly for future profitability. And indeed, during the period the company didn't produce any free cash flow whatsoever. In the last twelve months it actually had negative free cash flow, with an outflow of CN¥12m despite its profit of CN¥39.4m, mentioned above. We also note that Lushang Life Services' free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥12m.

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

Our Take On Lushang Life Services' Profit Performance

As we have made quite clear, we're a bit worried that Lushang Life Services didn't back up the last year's profit with free cashflow. As a result, we think it may well be the case that Lushang Life Services' underlying earnings power is lower than its statutory profit. Sadly, its EPS was down over the last twelve months. Of course, we've only just scratched the surface when it comes to analysing its earnings; one could also consider margins, forecast growth, and return on investment, among other factors. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. For example, Lushang Life Services has 3 warning signs (and 1 which makes us a bit uncomfortable) we think you should know about.

Today we've zoomed in on a single data point to better understand the nature of Lushang Life Services' profit. But there are plenty of other ways to inform your opinion of a company. 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.