Are DAIEISANGYOLtd's (FKSE:2974) Statutory Earnings A Good Reflection Of Its Earnings Potential?

Broadly speaking, profitable businesses are less risky than unprofitable ones. That said, the current statutory profit is not always a good guide to a company's underlying profitability. Today we'll focus on whether this year's statutory profits are a good guide to understanding DAIEISANGYOLtd (FKSE:2974).

While DAIEISANGYOLtd was able to generate revenue of JP¥28.9b in the last twelve months, we think its profit result of JP¥626.0m was more important. As you can see in the chart below, its profit has declined over the last three years, even though its revenue has increased.

Check out our latest analysis for DAIEISANGYOLtd

Not all profits are equal, and we can learn more about the nature of a company's past profitability by diving deeper into the financial statements. So today we'll look at what DAIEISANGYOLtd's cashflow tells us about the quality of its earnings. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of DAIEISANGYOLtd.

Examining Cashflow Against DAIEISANGYOLtd's Earnings

As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. 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'.

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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

DAIEISANGYOLtd has an accrual ratio of 0.24 for the year to September 2020. We can therefore deduce that its free cash flow fell well short of covering its statutory profit. In the last twelve months it actually had negative free cash flow, with an outflow of JP¥2.5b despite its profit of JP¥626.0m, mentioned above. We saw that FCF was JP¥3.5b a year ago though, so DAIEISANGYOLtd has at least been able to generate positive FCF in the past. One positive for DAIEISANGYOLtd shareholders is that it's accrual ratio was significantly better last year, providing reason to believe that it may return to stronger cash conversion in the future. Shareholders should look for improved cashflow relative to profit in the current year, if that is indeed the case.

Our Take On DAIEISANGYOLtd's Profit Performance

DAIEISANGYOLtd's accrual ratio for the last twelve months signifies cash conversion is less than ideal, which is a negative when it comes to our view of its earnings. Because of this, we think that it may be that DAIEISANGYOLtd's statutory profits are better than its underlying earnings power. Sadly, its EPS was down 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 DAIEISANGYOLtd as a business, it's important to be aware of any risks it's facing. Be aware that DAIEISANGYOLtd is showing 6 warning signs in our investment analysis and 3 of those are potentially serious...

This note has only looked at a single factor that sheds light on the nature of DAIEISANGYOLtd'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 that insiders are buying.

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This article by Simply Wall St is general in nature. 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.
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