Ling Yue Services Group's (HKG:2165) Shareholders May Want To Dig Deeper Than Statutory Profit

Ling Yue Services Group Limited's (HKG:2165) robust recent earnings didn't do much to move the stock. We believe that shareholders have noticed some concerning factors beyond the statutory profit numbers.

See our latest analysis for Ling Yue Services Group

Examining Cashflow Against Ling Yue Services Group'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. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Over the twelve months to June 2022, Ling Yue Services Group recorded an accrual ratio of 1.26. 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¥8.7m, in contrast to the aforementioned profit of CN¥80.9m. It's worth noting that Ling Yue Services Group generated positive FCF of CN¥143m a year ago, so at least they've done it in the past. The good news for shareholders is that Ling Yue Services Group's accrual ratio was much better last year, so this year's poor reading might simply be a case of a short term mismatch between profit and FCF. Shareholders should look for improved cashflow relative to profit in the current year, if that is indeed the case.

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

Our Take On Ling Yue Services Group's Profit Performance

As we have made quite clear, we're a bit worried that Ling Yue Services Group didn't back up the last year's profit with free cashflow. For this reason, we think that Ling Yue Services Group's statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. In further bad news, its earnings per share decreased 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 while earnings quality is important, it's equally important to consider the risks facing Ling Yue Services Group at this point in time. Be aware that Ling Yue Services Group is showing 3 warning signs in our investment analysis and 1 of those is potentially serious...

Today we've zoomed in on a single data point to better understand the nature of Ling Yue Services 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. 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.