Impressive Earnings May Not Tell The Whole Story For ITOCHU-SHOKUHIN (TSE:2692)

Despite announcing strong earnings, ITOCHU-SHOKUHIN Co., Ltd.'s (TSE:2692) stock was sluggish. We did some digging and found some worrying underlying problems.

See our latest analysis for ITOCHU-SHOKUHIN

A Closer Look At ITOCHU-SHOKUHIN's Earnings

Many investors haven't heard of the accrual ratio from cashflow, but it is actually a useful measure of how well a company's profit is backed up by free cash flow (FCF) during a given period. 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.

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

Over the twelve months to September 2024, ITOCHU-SHOKUHIN recorded an accrual ratio of 0.38. Statistically speaking, that's a real negative for future earnings. To wit, the company did not generate one whit of free cashflow in that time. Even though it reported a profit of JP¥8.22b, a look at free cash flow indicates it actually burnt through JP¥12b in the last year. It's worth noting that ITOCHU-SHOKUHIN generated positive FCF of JP¥11b a year ago, so at least they've done it in the past. One positive for ITOCHU-SHOKUHIN 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.

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

Our Take On ITOCHU-SHOKUHIN's Profit Performance

As we discussed above, we think ITOCHU-SHOKUHIN'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 ITOCHU-SHOKUHIN's underlying earnings power is lower than its statutory profit. But the good news is that its EPS growth over the last three years has been very impressive. 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. In light of this, if you'd like to do more analysis on the company, it's vital to be informed of the risks involved. For example - ITOCHU-SHOKUHIN has 1 warning sign we think you should be aware of.

Today we've zoomed in on a single data point to better understand the nature of ITOCHU-SHOKUHIN's profit. 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. While it might take a little research on your behalf, you may find this free collection of companies boasting high return on equity, or this list of stocks with significant insider holdings to be useful.

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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.