Luhai Holding (TPE:2115) Is Growing Earnings But Are They A Good Guide?

It might be old fashioned, but we really like to invest in companies that make a profit, each and every year. Having said that, sometimes statutory profit levels are not a good guide to ongoing profitability, because some short term one-off factor has impacted profit levels. Today we'll focus on whether this year's statutory profits are a good guide to understanding Luhai Holding (TPE:2115).

It's good to see that over the last twelve months Luhai Holding made a profit of NT$552.1m on revenue of NT$2.45b. Even though its revenue is down over the last three years, its profit has actually increased, as you can see, below.

Check out our latest analysis for Luhai Holding

Of course, it is only sensible to look beyond the statutory profits and question how well those numbers represent the sustainable earnings power of the business. So today we'll look at what Luhai Holding's cashflow tells us about the quality of its earnings. That might leave you wondering what analysts are forecasting in terms of future profitability. Luckily, you can click here to see an interactive graph depicting future profitability, based on their estimates.

A Closer Look At Luhai Holding'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. 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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

That means a negative accrual ratio is a good thing, because it shows that the company is bringing in more free cash flow than its profit would suggest. 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".

Luhai Holding has an accrual ratio of 0.42 for the year to September 2020. 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 NT$343m, in contrast to the aforementioned profit of NT$552.1m. We also note that Luhai Holding's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of NT$343m.

Our Take On Luhai Holding's Profit Performance

As we discussed above, we think Luhai Holding's earnings were not supported by free cash flow, which might concern some investors. As a result, we think it may well be the case that Luhai Holding's underlying earnings power is lower than its statutory profit. But the good news is that its EPS growth over the last three years has been very impressive. 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. If you want to do dive deeper into Luhai Holding, you'd also look into what risks it is currently facing. For example, Luhai Holding has 2 warning signs (and 1 which can't be ignored) we think you should know about.

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