The most recent earnings report from Li Ning Company Limited (HKG:2331) was disappointing for shareholders. However, our analysis suggests that the soft headline numbers are getting counterbalanced by some positive underlying factors.
A Closer Look At Li Ning's Earnings
As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. 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. 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".
Li Ning has an accrual ratio of -0.17 for the year to December 2024. Therefore, its statutory earnings were very significantly less than its free cashflow. To wit, it produced free cash flow of CN¥5.3b during the period, dwarfing its reported profit of CN¥3.01b. Li Ning shareholders are no doubt pleased that free cash flow improved over the last twelve months.
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 Li Ning's Profit Performance
Happily for shareholders, Li Ning produced plenty of free cash flow to back up its statutory profit numbers. Based on this observation, we consider it possible that Li Ning's statutory profit actually understates its earnings potential! On the other hand, its EPS actually shrunk in the last twelve months. At the end of the day, it's essential to consider more than just the factors above, if you want to understand the company properly. So while earnings quality is important, it's equally important to consider the risks facing Li Ning at this point in time. Every company has risks, and we've spotted 1 warning sign for Li Ning you should know about.
Today we've zoomed in on a single data point to better understand the nature of Li Ning's profit. But there is always more to discover if you are capable of focussing your mind on minutiae. 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. 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.