Are Hokkai Electrical Construction CompanyIncorporated's (SPSE:1832) Statutory Earnings A Good Guide To Its Underlying Profitability?

As a general rule, we think profitable companies are less risky than companies that lose money. 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. Today we'll focus on whether this year's statutory profits are a good guide to understanding Hokkai Electrical Construction CompanyIncorporated (SPSE:1832).

It's good to see that over the last twelve months Hokkai Electrical Construction CompanyIncorporated made a profit of JP¥1.05b on revenue of JP¥59.5b. While it managed to grow its revenue over the last three years, its profit has moved in the other direction, as you can see in the chart below.

Check out our latest analysis for Hokkai Electrical Construction CompanyIncorporated

Of course, it is only sensible to look beyond the statutory profits and question how well those numbers represent the sustainable earnings power of the business. Today, we'll discuss Hokkai Electrical Construction CompanyIncorporated's free cashflow relative to its earnings, and consider what that tells us about the company. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Hokkai Electrical Construction CompanyIncorporated.

Zooming In On Hokkai Electrical Construction CompanyIncorporated's Earnings

In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). 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'.

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 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

For the year to September 2020, Hokkai Electrical Construction CompanyIncorporated had an accrual ratio of -0.15. That indicates that its free cash flow quite significantly exceeded its statutory profit. Indeed, in the last twelve months it reported free cash flow of JP¥3.7b, well over the JP¥1.05b it reported in profit. Hokkai Electrical Construction CompanyIncorporated's free cash flow improved over the last year, which is generally good to see.

Our Take On Hokkai Electrical Construction CompanyIncorporated's Profit Performance

Hokkai Electrical Construction CompanyIncorporated's accrual ratio is solid, and indicates strong free cash flow, as we discussed, above. Based on this observation, we consider it likely that Hokkai Electrical Construction CompanyIncorporated'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. While earnings are important, another area to consider is the balance sheet. If you're interested we have a graphic representation of Hokkai Electrical Construction CompanyIncorporated's balance sheet.

Today we've zoomed in on a single data point to better understand the nature of Hokkai Electrical Construction CompanyIncorporated's 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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