Should You Rely On Lian Hwa Foods's (TPE:1231) Earnings Growth?

Broadly speaking, profitable businesses are less risky than unprofitable ones. However, sometimes companies receive a one-off boost (or reduction) to their profit, and it's not always clear whether statutory profits are a good guide, going forward. Today we'll focus on whether this year's statutory profits are a good guide to understanding Lian Hwa Foods (TPE:1231).

We like the fact that Lian Hwa Foods made a profit of NT$651.2m on its revenue of NT$8.76b, in the last year. One positive is that it has grown both its profit and its revenue, over the last few years.

Check out our latest analysis for Lian Hwa Foods

Importantly, statutory profits are not always the best tool for understanding a company's true earnings power, so it's well worth examining profits in a little more detail. Today, we'll discuss Lian Hwa Foods' free cashflow relative to its earnings, and consider what that tells us about the company. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Lian Hwa Foods.

Examining Cashflow Against Lian Hwa Foods' Earnings

In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). 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'.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. While having an accrual ratio above zero is of little concern, we do think it's worth noting when a company has a relatively high accrual ratio. 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 September 2020, Lian Hwa Foods recorded an accrual ratio of 0.35. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, raising questions about how useful that profit figure really is. In the last twelve months it actually had negative free cash flow, with an outflow of NT$1.3b despite its profit of NT$651.2m, mentioned above. We saw that FCF was NT$444m a year ago though, so Lian Hwa Foods has at least been able to generate positive FCF in the past.

Our Take On Lian Hwa Foods' Profit Performance

As we have made quite clear, we're a bit worried that Lian Hwa Foods didn't back up the last year's profit with free cashflow. As a result, we think it may well be the case that Lian Hwa Foods' underlying earnings power is lower than its statutory profit. But at least holders can take some solace from the 52% per annum growth in EPS for the last three. 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 Lian Hwa Foods, you'd also look into what risks it is currently facing. For example, we've discovered 2 warning signs that you should run your eye over to get a better picture of Lian Hwa Foods.

Today we've zoomed in on a single data point to better understand the nature of Lian Hwa Foods' profit. But there is always more to discover if you are capable of focussing your mind on minutiae. For example, many people consider a high return on equity as an indication of favorable business economics, while others like to 'follow the money' and search out stocks that insiders are buying. 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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