Impressive Earnings May Not Tell The Whole Story For O'will (TSE:3143)

Investors were disappointed with O'will Corporation's (TSE:3143) earnings, despite the strong profit numbers. Our analysis uncovered some concerning factors that we believe the market might be paying attention to.

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Examining Cashflow Against O'will'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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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 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. 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 March 2025, O'will recorded an accrual ratio of 0.30. 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¥875m, in contrast to the aforementioned profit of JP¥915.0m. We saw that FCF was JP¥67m a year ago though, so O'will has at least been able to generate positive FCF in the past. However, that's not all there is to consider. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio.

Check out our latest analysis for O'will

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

How Do Unusual Items Influence Profit?

The fact that the company had unusual items boosting profit by JP¥172m, in the last year, probably goes some way to explain why its accrual ratio was so weak. While it's always nice to have higher profit, a large contribution from unusual items sometimes dampens our enthusiasm. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And, after all, that's exactly what the accounting terminology implies. If O'will doesn't see that contribution repeat, then all else being equal we'd expect its profit to drop over the current year.

Our Take On O'will's Profit Performance

Summing up, O'will 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 O'will's statutory profits might make it look better than it really is on an underlying level. If you want to do dive deeper into O'will, you'd also look into what risks it is currently facing. For example, O'will has 3 warning signs (and 1 which shouldn't be ignored) we think you should know about.

Our examination of O'will has focussed on certain factors that can make its earnings look better than they are. And, on that basis, we are somewhat skeptical. But there are plenty of other ways to inform your opinion of a company. Some people consider a high return on equity to be a good sign of a quality business. 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.