Solid Earnings Reflect Meiji Electric IndustriesLtd's (TSE:3388) Strength As A Business

The subdued stock price reaction suggests that Meiji Electric Industries Co.,Ltd.'s (TSE:3388) strong earnings didn't offer any surprises. Our analysis suggests that investors might be missing some promising details.

View our latest analysis for Meiji Electric IndustriesLtd

A Closer Look At Meiji Electric IndustriesLtd's Earnings

Many investors haven't heard of the accrual ratio from cashflow, but it is actually a useful measure of how well a company's profit is backed up by free cash flow (FCF) during a given period. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. 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 it's not a problem to have a positive accrual ratio, indicating a certain level of non-cash profits, a high accrual ratio is arguably a bad thing, because it indicates paper profits are not matched by cash flow. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Meiji Electric IndustriesLtd has an accrual ratio of -0.11 for the year to March 2024. That indicates that its free cash flow was a fair bit more than its statutory profit. To wit, it produced free cash flow of JP¥5.3b during the period, dwarfing its reported profit of JP¥2.43b. Notably, Meiji Electric IndustriesLtd had negative free cash flow last year, so the JP¥5.3b it produced this year was a welcome improvement.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Meiji Electric IndustriesLtd.

Our Take On Meiji Electric IndustriesLtd's Profit Performance

Meiji Electric IndustriesLtd's accrual ratio is solid, and indicates strong free cash flow, as we discussed, above. Based on this observation, we consider it likely that Meiji Electric IndustriesLtd's statutory profit actually understates its earnings potential! And the EPS is up 45% annually, 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. If you want to do dive deeper into Meiji Electric IndustriesLtd, you'd also look into what risks it is currently facing. When we did our research, we found 2 warning signs for Meiji Electric IndustriesLtd (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 Meiji Electric IndustriesLtd's profit. But there are plenty of other ways to inform your opinion of a company. 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.