The subdued market reaction suggests that Lung Kee (Bermuda) Holdings Limited's (HKG:255) recent earnings didn't contain any surprises. However, we believe that investors should be aware of some underlying factors which may be of concern.

See our latest analysis for Lung Kee (Bermuda) Holdings

A Closer Look At Lung Kee (Bermuda) Holdings' 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). 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. This ratio tells us how much of a company's profit is not backed by free cashflow.

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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

For the year to June 2022, Lung Kee (Bermuda) Holdings had an accrual ratio of 0.22. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, which is hardly a good thing. Over the last year it actually had negative free cash flow of HK$122m, in contrast to the aforementioned profit of HK$160.8m. We saw that FCF was HK$294m a year ago though, so Lung Kee (Bermuda) Holdings has at least been able to generate positive FCF in the past. The good news for shareholders is that Lung Kee (Bermuda) Holdings' accrual ratio was much better last year, so this year's poor reading might simply be a case of a short term mismatch between profit and FCF. As a result, some shareholders may be looking for stronger cash conversion in the current year.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Lung Kee (Bermuda) Holdings.

Our Take On Lung Kee (Bermuda) Holdings' Profit Performance

Lung Kee (Bermuda) Holdings didn't convert much of its profit to free cash flow in the last year, which some investors may consider rather suboptimal. Therefore, it seems possible to us that Lung Kee (Bermuda) Holdings' true underlying earnings power is actually less than its statutory profit. Nonetheless, it's still worth noting that its earnings per share have grown at 37% over the last three years. 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 Lung Kee (Bermuda) Holdings, you'd also look into what risks it is currently facing. Case in point: We've spotted 3 warning signs for Lung Kee (Bermuda) Holdings you should be aware of.

Today we've zoomed in on a single data point to better understand the nature of Lung Kee (Bermuda) Holdings' profit. But there are plenty of other ways to inform your opinion of a company. 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. 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.