Three FLtd's (TSE:7544) Strong Earnings Are Of Good Quality

Even though Three F Co.,Ltd.'s (TSE:7544) recent earnings release was robust, the market didn't seem to notice. Our analysis suggests that investors might be missing some promising details.

Check out our latest analysis for Three FLtd

Zooming In On Three FLtd'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. 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.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

For the year to August 2024, Three FLtd had an accrual ratio of -1.62. Therefore, its statutory earnings were very significantly less than its free cashflow. To wit, it produced free cash flow of JP¥716m during the period, dwarfing its reported profit of JP¥263.0m. Three FLtd shareholders are no doubt pleased that free cash flow improved over the last twelve months.

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

Our Take On Three FLtd's Profit Performance

Happily for shareholders, Three FLtd produced plenty of free cash flow to back up its statutory profit numbers. Based on this observation, we consider it possible that Three FLtd's statutory profit actually understates its earnings potential! And it's also positive that the company showed enough improvement to book a profit this year, after losing money last year. 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. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. At Simply Wall St, we found 2 warning signs for Three FLtd and we think they deserve your attention.

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