Statutory Profit Doesn't Reflect How Good Watanabe Sato's (TSE:1807) Earnings Are

The subdued stock price reaction suggests that Watanabe Sato Co., Ltd.'s (TSE:1807) strong earnings didn't offer any surprises. We think that investors have missed some encouraging factors underlying the profit figures.

View our latest analysis for Watanabe Sato

Examining Cashflow Against Watanabe Sato'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. 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.

For the year to March 2024, Watanabe Sato had an accrual ratio of -0.13. That implies it has good cash conversion, and implies that its free cash flow solidly exceeded its profit last year. To wit, it produced free cash flow of JP¥3.0b during the period, dwarfing its reported profit of JP¥1.20b. Given that Watanabe Sato had negative free cash flow in the prior corresponding period, the trailing twelve month resul of JP¥3.0b would seem to be a step in the right direction.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Watanabe Sato.

Our Take On Watanabe Sato's Profit Performance

Watanabe Sato's accrual ratio is solid, and indicates strong free cash flow, as we discussed, above. Because of this, we think Watanabe Sato's earnings potential is at least as good as it seems, and maybe even better! And on top of that, its earnings per share have grown at an extremely impressive rate over the last year. 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. If you'd like to know more about Watanabe Sato as a business, it's important to be aware of any risks it's facing. When we did our research, we found 2 warning signs for Watanabe Sato (1 shouldn't be ignored!) that we believe deserve your full attention.

This note has only looked at a single factor that sheds light on the nature of Watanabe Sato's profit. But there is always more to discover if you are capable of focussing your mind on minutiae. 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.

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

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.