Daiichi Jitsugyo's (TSE:8059) Shareholders May Want To Dig Deeper Than Statutory Profit

Following the solid earnings report from Daiichi Jitsugyo Co., Ltd. (TSE:8059), the market responded by bidding up the stock price. While the profit numbers were good, our analysis has found some concerning factors that shareholders should be aware of.

Check out our latest analysis for Daiichi Jitsugyo

Examining Cashflow Against Daiichi Jitsugyo'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. The ratio shows us how much a company's profit exceeds its FCF.

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 March 2024, Daiichi Jitsugyo had an accrual ratio of 0.24. 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¥2.4b despite its profit of JP¥7.46b, mentioned above. It's worth noting that Daiichi Jitsugyo generated positive FCF of JP¥8.1b a year ago, so at least they've done it in the past. Having said that, there is more to the story. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio. The good news for shareholders is that Daiichi Jitsugyo's accrual ratio was much better last year, so this year's poor reading might simply be a case of a short term mismatch between profit and FCF. 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 Daiichi Jitsugyo.

How Do Unusual Items Influence Profit?

Given the accrual ratio, it's not overly surprising that Daiichi Jitsugyo's profit was boosted by unusual items worth JP¥1.5b in the last twelve months. While we like to see profit increases, we tend to be a little more cautious when unusual items have made a big contribution. We ran the numbers on most publicly listed companies worldwide, and it's very common for unusual items to be once-off in nature. And that's as you'd expect, given these boosts are described as 'unusual'. If Daiichi Jitsugyo doesn't see that contribution repeat, then all else being equal we'd expect its profit to drop over the current year.

Our Take On Daiichi Jitsugyo's Profit Performance

Daiichi Jitsugyo had a weak accrual ratio, but its profit did receive a boost from unusual items. For the reasons mentioned above, we think that a perfunctory glance at Daiichi Jitsugyo's statutory profits might make it look better than it really is on an underlying level. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. Be aware that Daiichi Jitsugyo is showing 2 warning signs in our investment analysis and 1 of those is a bit concerning...

Our examination of Daiichi Jitsugyo has focussed on certain factors that can make its earnings look better than they are. And, on that basis, we are somewhat skeptical. 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.

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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.