There May Be Underlying Issues With The Quality Of MEISEI INDUSTRIALLtd's (TSE:1976) Earnings

Unsurprisingly, MEISEI INDUSTRIAL Co.,Ltd.'s (TSE:1976) stock price was strong on the back of its healthy earnings report. We did some analysis and think that investors are missing some details hidden beneath the profit numbers.

View our latest analysis for MEISEI INDUSTRIALLtd

Examining Cashflow Against MEISEI INDUSTRIALLtd'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. 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".

For the year to September 2024, MEISEI INDUSTRIALLtd had an accrual ratio of 0.23. Unfortunately, that means its free cash flow fell significantly short of its reported profits. In the last twelve months it actually had negative free cash flow, with an outflow of JP¥399m despite its profit of JP¥6.96b, mentioned above. We saw that FCF was JP¥5.1b a year ago though, so MEISEI INDUSTRIALLtd has at least been able to generate positive FCF in the past. One positive for MEISEI INDUSTRIALLtd shareholders is that it's accrual ratio was significantly better last year, providing reason to believe that it may return to stronger cash conversion in the future. Shareholders should look for improved cashflow relative to profit in the current year, if that is indeed the case.

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

Our Take On MEISEI INDUSTRIALLtd's Profit Performance

MEISEI INDUSTRIALLtd's accrual ratio for the last twelve months signifies cash conversion is less than ideal, which is a negative when it comes to our view of its earnings. Therefore, it seems possible to us that MEISEI INDUSTRIALLtd's true underlying earnings power is actually less than its statutory profit. But the good news is that its EPS growth over the last three years has been very impressive. 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. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. For example, we've found that MEISEI INDUSTRIALLtd has 2 warning signs (1 can't be ignored!) that deserve your attention before going any further with your analysis.

Today we've zoomed in on a single data point to better understand the nature of MEISEI INDUSTRIALLtd'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. While it might take a little research on your behalf, you may find this free collection of companies boasting high return on equity, or this list of stocks with significant insider holdings to be useful.

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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.