Investors were disappointed with the weak earnings posted by Landsea Green Life Service Company Limited (HKG:1965 ). Despite the soft profit numbers, our analysis has optimistic about the overall quality of the income statement.

Check out our latest analysis for Landsea Green Life Service

Zooming In On Landsea Green Life Service's Earnings

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

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 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. 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 June 2023, Landsea Green Life Service recorded an accrual ratio of -0.68. That indicates that its free cash flow quite significantly exceeded its statutory profit. In fact, it had free cash flow of CN¥145m in the last year, which was a lot more than its statutory profit of CN¥19.3m. Notably, Landsea Green Life Service had negative free cash flow last year, so the CN¥145m it produced this year was a welcome improvement. Having said that, there is more to the story. 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 Landsea Green Life Service.

The Impact Of Unusual Items On Profit

While the accrual ratio might bode well, we also note that Landsea Green Life Service's profit was boosted by unusual items worth CN¥2.3m in the last twelve months. While it's always nice to have higher profit, a large contribution from unusual items sometimes dampens our enthusiasm. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And that's as you'd expect, given these boosts are described as 'unusual'. If Landsea Green Life Service 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 Landsea Green Life Service's Profit Performance

In conclusion, Landsea Green Life Service'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 Landsea Green Life Service's profit result is a pretty good guide to its true profitability, albeit a bit on the conservative side. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. To help with this, we've discovered 5 warning signs (2 can't be ignored!) that you ought to be aware of before buying any shares in Landsea Green Life Service.

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 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. 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.