We Think DRAFT's (TSE:5070) Profit Is Only A Baseline For What They Can Achieve

Investors were underwhelmed by the solid earnings posted by DRAFT Inc. (TSE:5070) recently. Our analysis says that investors should be optimistic, as the strong profit is built on solid foundations.

View our latest analysis for DRAFT

Zooming In On DRAFT's Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. To get the accrual ratio we first subtract FCF from profit for a period, and then divide that number by the average operating assets for the period. 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

DRAFT has an accrual ratio of -0.17 for the year to December 2024. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. In fact, it had free cash flow of JP¥1.1b in the last year, which was a lot more than its statutory profit of JP¥646.0m. Notably, DRAFT had negative free cash flow last year, so the JP¥1.1b 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 DRAFT.

Our Take On DRAFT's Profit Performance

As we discussed above, DRAFT's accrual ratio indicates strong conversion of profit to free cash flow, which is a positive for the company. Based on this observation, we consider it possible that DRAFT's statutory profit actually understates its earnings potential! And the EPS is up 25% over the last twelve months. 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. If you'd like to know more about DRAFT as a business, it's important to be aware of any risks it's facing. At Simply Wall St, we found 1 warning sign for DRAFT and we think they deserve your attention.

This note has only looked at a single factor that sheds light on the nature of DRAFT'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.