Concerns Surrounding Eternal Hospitality GroupLtd's (TSE:3193) Performance

Eternal Hospitality Group Co.,Ltd.'s (TSE:3193) healthy profit numbers didn't contain any surprises for investors. We think this is due to investors looking beyond the statutory profits and being concerned with what they see.

Zooming In On Eternal Hospitality GroupLtd'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. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. The ratio shows us how much a company's profit exceeds its FCF.

That means a negative accrual ratio is a good thing, because it shows that the company is bringing in more free cash flow than its profit would suggest. 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Eternal Hospitality GroupLtd has an accrual ratio of 0.21 for the year to January 2025. Unfortunately, that means its free cash flow fell significantly short of its reported profits. To wit, it produced free cash flow of JP¥850m during the period, falling well short of its reported profit of JP¥1.82b. Eternal Hospitality GroupLtd shareholders will no doubt be hoping that its free cash flow bounces back next year, since it was down over the last twelve months. The good news for shareholders is that Eternal Hospitality GroupLtd's accrual ratio was much better last year, so this year's poor reading might simply be a case of a short term mismatch between profit and FCF. Shareholders should look for improved cashflow relative to profit in the current year, if that is indeed the case.

That might leave you wondering what analysts are forecasting in terms of future profitability. Luckily, you can click here to see an interactive graph depicting future profitability, based on their estimates.

Our Take On Eternal Hospitality GroupLtd's Profit Performance

Eternal Hospitality GroupLtd's accrual ratio for the last twelve months signifies cash conversion is less than ideal, which is a negative when it comes to our view of its earnings. Because of this, we think that it may be that Eternal Hospitality GroupLtd's statutory profits are better than its underlying earnings power. But at least holders can take some solace from the 42% per annum growth in EPS for the last three. 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. If you'd like to know more about Eternal Hospitality GroupLtd as a business, it's important to be aware of any risks it's facing. You'd be interested to know, that we found 1 warning sign for Eternal Hospitality GroupLtd and you'll want to know about this.

This note has only looked at a single factor that sheds light on the nature of Eternal Hospitality GroupLtd's profit. 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. 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.