Statutory Profit Doesn't Reflect How Good Towa Food Service's (TSE:3329) Earnings Are

Towa Food Service Co., Ltd. (TSE:3329) just reported healthy earnings but the stock price didn't move much. Investors are probably missing some underlying factors which are encouraging for the future of the company.

View our latest analysis for Towa Food Service

A Closer Look At Towa Food Service's Earnings

In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). 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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Towa Food Service has an accrual ratio of -0.10 for the year to April 2024. That indicates that its free cash flow was a fair bit more than its statutory profit. To wit, it produced free cash flow of JP¥974m during the period, dwarfing its reported profit of JP¥704.0m. Towa Food Service 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 Towa Food Service.

Our Take On Towa Food Service's Profit Performance

As we discussed above, Towa Food Service has perfectly satisfactory free cash flow relative to profit. Based on this observation, we consider it likely that Towa Food Service's statutory profit actually understates its earnings potential! And the EPS is up 66% over the last twelve months. 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. Just as investors must consider earnings, it is also important to take into account the strength of a company's balance sheet. You can see our latest analysis on Towa Food Service's balance sheet health here.

Today we've zoomed in on a single data point to better understand the nature of Towa Food Service'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. 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.

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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.