IMAGE MAGIC's (TSE:7793) Profits May Not Reveal Underlying Issues

The market for IMAGE MAGIC Inc.'s (TSE:7793) stock was strong after it released a healthy earnings report last week. While the profit numbers were good, our analysis has found some concerning factors that shareholders should be aware of.

This technology could replace computers: discover the 20 stocks are working to make quantum computing a reality.

Zooming In On IMAGE MAGIC'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. This ratio tells us how much of a company's profit is not backed by free cashflow.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. While having an accrual ratio above zero is of little concern, we do think it's worth noting when a company has a relatively high accrual ratio. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

For the year to June 2025, IMAGE MAGIC had an accrual ratio of 0.25. We can therefore deduce that its free cash flow fell well short of covering its statutory profit. Over the last year it actually had negative free cash flow of JP¥37m, in contrast to the aforementioned profit of JP¥279.0m. We saw that FCF was JP¥177m a year ago though, so IMAGE MAGIC has at least been able to generate positive FCF in the past. However, that's not all there is to consider. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part.

Check out our latest analysis for IMAGE MAGIC

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

The Impact Of Unusual Items On Profit

Unfortunately (in the short term) IMAGE MAGIC saw its profit reduced by unusual items worth JP¥102m. In the case where this was a non-cash charge it would have made it easier to have high cash conversion, so it's surprising that the accrual ratio tells a different story. It's never great to see unusual items costing the company profits, but on the upside, things might improve sooner rather than later. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And, after all, that's exactly what the accounting terminology implies. If IMAGE MAGIC doesn't see those unusual expenses repeat, then all else being equal we'd expect its profit to increase over the coming year.

Our Take On IMAGE MAGIC's Profit Performance

IMAGE MAGIC saw unusual items weigh on its profit, which should have made it easier to show high cash conversion, which it did not do, according to its accrual ratio. Given the contrasting considerations, we don't have a strong view as to whether IMAGE MAGIC's profits are an apt reflection of its underlying potential for profit. So while earnings quality is important, it's equally important to consider the risks facing IMAGE MAGIC at this point in time. Every company has risks, and we've spotted 2 warning signs for IMAGE MAGIC (of which 1 makes us a bit uncomfortable!) you should know about.

Our examination of IMAGE MAGIC has focussed on certain factors that can make its earnings look better than they are. 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. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.