Statutory Profit Doesn't Reflect How Good HouseFreedomLtd's (FKSE:8996) Earnings Are

The subdued stock price reaction suggests that HouseFreedom Co.,Ltd.'s (FKSE:8996) strong earnings didn't offer any surprises. Investors are probably missing some underlying factors which are encouraging for the future of the company.

See our latest analysis for HouseFreedomLtd

A Closer Look At HouseFreedomLtd'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. 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.

Therefore, it's actually considered a good thing when a company has a negative accrual ratio, but a bad thing if its accrual ratio is positive. While it's not a problem to have a positive accrual ratio, indicating a certain level of non-cash profits, a high accrual ratio is arguably a bad thing, because it indicates paper profits are not matched by cash flow. 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 December 2020, HouseFreedomLtd had an accrual ratio of -0.10. Therefore, its statutory earnings were quite a lot less than its free cashflow. Indeed, in the last twelve months it reported free cash flow of JP¥1.1b, well over the JP¥559.0m it reported in profit. Given that HouseFreedomLtd had negative free cash flow in the prior corresponding period, the trailing twelve month resul of JP¥1.1b would seem to be a step in the right direction.

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

Our Take On HouseFreedomLtd's Profit Performance

As we discussed above, HouseFreedomLtd has perfectly satisfactory free cash flow relative to profit. Based on this observation, we consider it likely that HouseFreedomLtd's statutory profit actually understates its earnings potential! And on top of that, its earnings per share have grown at an extremely impressive rate over the last three years. At the end of the day, it's essential to consider more than just the factors above, if you want to understand the company properly. If you'd like to know more about HouseFreedomLtd as a business, it's important to be aware of any risks it's facing. Every company has risks, and we've spotted 4 warning signs for HouseFreedomLtd you should know about.

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