The subdued market reaction suggests that L.K. Technology Holdings Limited's (HKG:558) recent earnings didn't contain any surprises. Our analysis suggests that along with soft profit numbers, investors should be aware of some other underlying weaknesses in the numbers.

Zooming In On L.K. Technology 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. 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.

Over the twelve months to March 2024, L.K. Technology Holdings recorded an accrual ratio of 0.22. Unfortunately, that means its free cash flow fell significantly short of its reported profits. Over the last year it actually had negative free cash flow of HK$425m, in contrast to the aforementioned profit of HK$484.1m. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of HK$425m, this year, indicates high risk.

That might leave you wondering what analysts are forecasting in terms of future profitability. Luckily, you can click here to see an interactive graph depicting future profitability, based on their estimates.

Our Take On L.K. Technology Holdings' Profit Performance

L.K. Technology Holdings didn't convert much of its profit to free cash flow in the last year, which some investors may consider rather suboptimal. Because of this, we think that it may be that L.K. Technology Holdings' statutory profits are better than its underlying earnings power. Nonetheless, it's still worth noting that its earnings per share have grown at 34% over the last three years. 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'd like to know more about L.K. Technology Holdings as a business, it's important to be aware of any risks it's facing. Our analysis shows 2 warning signs for L.K. Technology Holdings (1 is significant!) and we strongly recommend you look at these bad boys before investing.

This note has only looked at a single factor that sheds light on the nature of L.K. Technology Holdings' 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 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com