We Think No.1Ltd's (TSE:3562) Robust Earnings Are Conservative

No.1 Co.,Ltd (TSE:3562) just reported healthy earnings but the stock price didn't move much. Investors are probably missing some underlying factors which are encouraging for the future of the company.

See our latest analysis for No.1Ltd

Zooming In On No.1Ltd'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'.

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 August 2024, No.1Ltd had an accrual ratio of -0.16. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. To wit, it produced free cash flow of JP¥1.2b during the period, dwarfing its reported profit of JP¥751.0m. No.1Ltd's free cash flow improved over the last year, which is generally good to see.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of No.1Ltd.

Our Take On No.1Ltd's Profit Performance

No.1Ltd's accrual ratio is solid, and indicates strong free cash flow, as we discussed, above. Because of this, we think No.1Ltd'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 51% per year over the last three years. Of course, we've only just scratched the surface when it comes to analysing its earnings; one could also consider margins, forecast growth, and return on investment, among other factors. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. Every company has risks, and we've spotted 2 warning signs for No.1Ltd you should know about.

Today we've zoomed in on a single data point to better understand the nature of No.1Ltd'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. 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.