Is There More To The Story Than Oriental Consultants Holdings's (TYO:2498) Earnings Growth?

Many investors consider it preferable to invest in profitable companies over unprofitable ones, because profitability suggests a business is sustainable. However, sometimes companies receive a one-off boost (or reduction) to their profit, and it's not always clear whether statutory profits are a good guide, going forward. This article will consider whether Oriental Consultants Holdings' (TYO:2498) statutory profits are a good guide to its underlying earnings.

It's good to see that over the last twelve months Oriental Consultants Holdings made a profit of JP¥1.54b on revenue of JP¥62.9b. In the chart below, you can see that its profit and revenue have both grown over the last three years.

Check out our latest analysis for Oriental Consultants Holdings

Importantly, statutory profits are not always the best tool for understanding a company's true earnings power, so it's well worth examining profits in a little more detail. So today we'll look at what Oriental Consultants Holdings' cashflow tells us about the quality of its earnings. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Oriental Consultants Holdings.

Zooming In On Oriental Consultants 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. 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'.

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 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. 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 September 2020, Oriental Consultants Holdings had an accrual ratio of -0.41. Therefore, its statutory earnings were very significantly less than its free cashflow. In fact, it had free cash flow of JP¥4.1b in the last year, which was a lot more than its statutory profit of JP¥1.54b. Notably, Oriental Consultants Holdings had negative free cash flow last year, so the JP¥4.1b it produced this year was a welcome improvement.

Our Take On Oriental Consultants Holdings' Profit Performance

Happily for shareholders, Oriental Consultants Holdings produced plenty of free cash flow to back up its statutory profit numbers. Based on this observation, we consider it possible that Oriental Consultants Holdings' statutory profit actually understates its earnings potential! And on top of that, its earnings per share have grown at 69% per year over the last three years. 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. While it's very important to consider the profit and loss statement, you can also learn a lot about a company by looking at its balance sheet. We've done some analysis and you can see our take on Oriental Consultants Holdings' balance sheet by clicking here.

Today we've zoomed in on a single data point to better understand the nature of Oriental Consultants 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 that insiders are buying.

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This article by Simply Wall St is general in nature. 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.
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