Investors Shouldn't Be Too Comfortable With Lokaty Budowlane's (WSE:LBD) Robust Earnings

Lokaty Budowlane S.A.'s (WSE:LBD) robust earnings report didn't manage to move the market for its stock. Our analysis suggests that shareholders have noticed something concerning in the numbers.

Check out our latest analysis for Lokaty Budowlane

Examining Cashflow Against Lokaty Budowlane'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. 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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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 December 2021, Lokaty Budowlane had an accrual ratio of 1.98. 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. Over the last year it actually had negative free cash flow of zł257k, in contrast to the aforementioned profit of zł4.37m. We also note that Lokaty Budowlane's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of zł257k.

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

Our Take On Lokaty Budowlane's Profit Performance

As we have made quite clear, we're a bit worried that Lokaty Budowlane didn't back up the last year's profit with free cashflow. For this reason, we think that Lokaty Budowlane's statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. On the bright side, the company showed enough improvement to book a profit this year, after losing money last year. At the end of the day, it's essential to consider more than just the factors above, if you want to understand the company properly. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. Be aware that Lokaty Budowlane is showing 6 warning signs in our investment analysis and 5 of those don't sit too well with us...

Today we've zoomed in on a single data point to better understand the nature of Lokaty Budowlane'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 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.