Statutory Profit Doesn't Reflect How Good Luo Lih-Fen Holding's (TWSE:6666) Earnings Are

Luo Lih-Fen Holding Co., Ltd. (TWSE:6666) just reported healthy earnings but the stock price didn't move much. We think that investors have missed some encouraging factors underlying the profit figures.

See our latest analysis for Luo Lih-Fen Holding

Examining Cashflow Against Luo Lih-Fen Holding'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. 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. The ratio shows us how much a company's profit exceeds its FCF.

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

Luo Lih-Fen Holding has an accrual ratio of -0.42 for the year to September 2024. That indicates that its free cash flow quite significantly exceeded its statutory profit. To wit, it produced free cash flow of NT$447m during the period, dwarfing its reported profit of NT$92.7m. Luo Lih-Fen Holding did see its free cash flow drop year on year, which is less than ideal, like a Simpson's episode without Groundskeeper Willie. Having said that, there is more to the story. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Luo Lih-Fen Holding.

The Impact Of Unusual Items On Profit

Surprisingly, given Luo Lih-Fen Holding's accrual ratio implied strong cash conversion, its paper profit was actually boosted by NT$8.8m in unusual items. We can't deny that higher profits generally leave us optimistic, but we'd prefer it if the profit were to be sustainable. 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. Which is hardly surprising, given the name. Assuming those unusual items don't show up again in the current year, we'd thus expect profit to be weaker next year (in the absence of business growth, that is).

Our Take On Luo Lih-Fen Holding's Profit Performance

In conclusion, Luo Lih-Fen Holding's accrual ratio suggests its statutory earnings are of good quality, but on the other hand the profits were boosted by unusual items. Considering all the aforementioned, we'd venture that Luo Lih-Fen Holding's profit result is a pretty good guide to its true profitability, albeit a bit on the conservative side. If you'd like to know more about Luo Lih-Fen Holding as a business, it's important to be aware of any risks it's facing. When we did our research, we found 3 warning signs for Luo Lih-Fen Holding (1 makes us a bit uncomfortable!) that we believe deserve your full attention.

In this article we've looked at a number of factors that can impair the utility of profit numbers, as a guide to a business. 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.