Why Three FLtd's (TSE:7544) Earnings Are Better Than They Seem

Three F Co.,Ltd. (TSE:7544) announced a healthy earnings result recently, and the market rewarded it with a strong uplift in the stock price. This reaction by the market reaction is understandable when looking at headline profits and we have found some further encouraging factors.

AI is about to change healthcare. These 20 stocks are working on everything from early diagnostics to drug discovery. The best part - they are all under $10bn in marketcap - there is still time to get in early.

Zooming In On Three FLtd'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. While it's not a problem to have a positive accrual ratio, indicating a certain level of non-cash profits, a high accrual ratio is arguably a bad thing, because it indicates paper profits are not matched by cash flow. 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 February 2025, Three FLtd recorded an accrual ratio of -1.00. That indicates that its free cash flow quite significantly exceeded its statutory profit. To wit, it produced free cash flow of JP¥473m during the period, dwarfing its reported profit of JP¥289.0m. Three FLtd's free cash flow actually declined over the last year, which is disappointing, like non-biodegradable balloons.

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. Because of this, we think Three FLtd's underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! And on top of that, its earnings per share increased by 34% 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. So while earnings quality is important, it's equally important to consider the risks facing Three FLtd at this point in time. Every company has risks, and we've spotted 2 warning signs for Three FLtd you should know about.

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

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.