Lian Hwa Foods (TWSE:1231) Posted Healthy Earnings But There Are Some Other Factors To Be Aware Of

Despite posting some strong earnings, the market for Lian Hwa Foods Corporation's (TWSE:1231) stock hasn't moved much. We did some digging, and we found some concerning factors in the details.

See our latest analysis for Lian Hwa Foods

Examining Cashflow Against Lian Hwa Foods' Earnings

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

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. 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Over the twelve months to September 2024, Lian Hwa Foods recorded an accrual ratio of 0.23. Unfortunately, that means its free cash flow fell significantly short of its reported profits. In the last twelve months it actually had negative free cash flow, with an outflow of NT$1.0b despite its profit of NT$1.21b, mentioned above. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of NT$1.0b, this year, indicates high risk. However, that's not all there is to consider. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Lian Hwa Foods.

The Impact Of Unusual Items On Profit

Given the accrual ratio, it's not overly surprising that Lian Hwa Foods' profit was boosted by unusual items worth NT$195m in the last twelve months. While we like to see profit increases, we tend to be a little more cautious when unusual items have made a big contribution. When we crunched the numbers on thousands of publicly listed companies, we found that a boost from unusual items in a given year is often not repeated the next year. And that's as you'd expect, given these boosts are described as 'unusual'. If Lian Hwa Foods doesn't see that contribution repeat, then all else being equal we'd expect its profit to drop over the current year.

Our Take On Lian Hwa Foods' Profit Performance

Summing up, Lian Hwa Foods received a nice boost to profit from unusual items, but could not match its paper profit with free cash flow. For the reasons mentioned above, we think that a perfunctory glance at Lian Hwa Foods' statutory profits might make it look better than it really is on an underlying level. If you'd like to know more about Lian Hwa Foods as a business, it's important to be aware of any risks it's facing. In terms of investment risks, we've identified 2 warning signs with Lian Hwa Foods, and understanding these bad boys should be part of your investment process.

In this article we've looked at a number of factors that can impair the utility of profit numbers, and we've come away cautious. 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. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks with high insider ownership.

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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.