Last week's earnings announcement from Lushang Life Services Co., Ltd. (HKG:2376) was disappointing to investors, with a sluggish profit figure. We did some analysis, and found that there are some reasons to be cautious about the headline numbers.

View our latest analysis for Lushang Life Services

Zooming In On Lushang Life Services' 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). 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. 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.

For the year to June 2023, Lushang Life Services had an accrual ratio of 1.82. Statistically speaking, that's a real negative for future earnings. And indeed, during the period the company didn't produce any free cash flow whatsoever. In the last twelve months it actually had negative free cash flow, with an outflow of CN¥91m despite its profit of CN¥66.6m, mentioned above. We saw that FCF was CN¥62m a year ago though, so Lushang Life Services has at least been able to generate positive FCF in the past.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Lushang Life Services.

Our Take On Lushang Life Services' Profit Performance

As we have made quite clear, we're a bit worried that Lushang Life Services didn't back up the last year's profit with free cashflow. For this reason, we think that Lushang Life Services' statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. Sadly, its EPS was down over the last twelve months. The goal of this article has been to assess how well we can rely on the statutory earnings to reflect the company's potential, but there is plenty more to consider. If you want to do dive deeper into Lushang Life Services, you'd also look into what risks it is currently facing. Be aware that Lushang Life Services is showing 3 warning signs in our investment analysis and 1 of those is a bit concerning...

Today we've zoomed in on a single data point to better understand the nature of Lushang Life Services' profit. But there are plenty of other ways to inform your opinion of a company. Some people consider a high return on equity to be a good sign of a quality business. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying.

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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.