When companies post strong earnings, the stock generally performs well, just like Lum Chang Holdings Limited's (SGX:L19) stock has recently. We have done some analysis, and we found several positive factors beyond the profit numbers.
Examining Cashflow Against Lum Chang Holdings' Earnings
One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. 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'.
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 it's not a problem to have a positive accrual ratio, indicating a certain level of non-cash profits, a high accrual ratio is arguably a bad thing, because it indicates paper profits are not matched by cash flow. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".
For the year to December 2024, Lum Chang Holdings had an accrual ratio of -0.45. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. To wit, it produced free cash flow of S$72m during the period, dwarfing its reported profit of S$7.23m. Given that Lum Chang Holdings had negative free cash flow in the prior corresponding period, the trailing twelve month resul of S$72m would seem to be a step in the right direction.
Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Lum Chang Holdings.
Our Take On Lum Chang Holdings' Profit Performance
As we discussed above, Lum Chang Holdings' accrual ratio indicates strong conversion of profit to free cash flow, which is a positive for the company. Because of this, we think Lum Chang Holdings' underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! And one can definitely find a positive in the fact that it made a profit this year, despite losing money last year. 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. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. For example, we've found that Lum Chang Holdings has 3 warning signs (1 is a bit unpleasant!) that deserve your attention before going any further with your analysis.
Today we've zoomed in on a single data point to better understand the nature of Lum Chang Holdings' profit. But there is always more to discover if you are capable of focussing your mind on minutiae. 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 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.
