CVS Bay Area's (TSE:2687) Attractive Earnings Are Not All Good News For Shareholders

We didn't see CVS Bay Area Inc.'s (TSE:2687) stock surge when it reported robust earnings recently. We think that investors might be worried about the foundations the earnings are built on.

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Examining Cashflow Against CVS Bay Area'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. 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. The ratio shows us how much a company's profit exceeds its FCF.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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".

CVS Bay Area has an accrual ratio of 0.30 for the year to February 2025. Unfortunately, that means its free cash flow was a lot less than its statutory profit, which makes us doubt the utility of profit as a guide. Over the last year it actually had negative free cash flow of JP¥1.1b, in contrast to the aforementioned profit of JP¥1.12b. We also note that CVS Bay Area's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of JP¥1.1b. 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.

View our latest analysis for CVS Bay Area

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

The Impact Of Unusual Items On Profit

Given the accrual ratio, it's not overly surprising that CVS Bay Area's profit was boosted by unusual items worth JP¥843m in the last twelve months. We can't deny that higher profits generally leave us optimistic, but we'd prefer it if the profit were to be sustainable. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And that's as you'd expect, given these boosts are described as 'unusual'. CVS Bay Area had a rather significant contribution from unusual items relative to its profit to February 2025. As a result, we can surmise that the unusual items are making its statutory profit significantly stronger than it would otherwise be.

Our Take On CVS Bay Area's Profit Performance

Summing up, CVS Bay Area received a nice boost to profit from unusual items, but could not match its paper profit with free cash flow. For the reasons mentioned above, we think that a perfunctory glance at CVS Bay Area's statutory profits might make it look better than it really is on an underlying level. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. Be aware that CVS Bay Area is showing 4 warning signs in our investment analysis and 2 of those make us uncomfortable...

In this article we've looked at a number of factors that can impair the utility of profit numbers, and we've come away cautious. But there is always more to discover if you are capable of focussing your mind on minutiae. Some people consider a high return on equity to be a good sign of a quality business. 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.