First-corporation's (TSE:1430) Profits Appear To Have Quality Issues

First-corporation Inc.'s (TSE:1430) healthy profit numbers didn't contain any surprises for investors. We think this is due to investors looking beyond the statutory profits and being concerned with what they see.

See our latest analysis for First-corporation

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

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. 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Over the twelve months to November 2024, First-corporation recorded an accrual ratio of 0.40. As a general rule, that bodes poorly for future profitability. And indeed, during the period the company didn't produce any free cash flow whatsoever. In the last twelve months it actually had negative free cash flow, with an outflow of JP¥3.1b despite its profit of JP¥1.52b, mentioned above. We also note that First-corporation's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of JP¥3.1b.

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

Our Take On First-corporation's Profit Performance

As we discussed above, we think First-corporation's earnings were not supported by free cash flow, which might concern some investors. As a result, we think it may well be the case that First-corporation's underlying earnings power is lower than its statutory profit. The good news is that, its earnings per share increased by 31% in the last year. 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. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. To that end, you should learn about the 5 warning signs we've spotted with First-corporation (including 2 which make us uncomfortable).

Today we've zoomed in on a single data point to better understand the nature of First-corporation'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.