Here's Why We Think Care Twentyone's (TYO:2373) Statutory Earnings Might Be Conservative

As a general rule, we think profitable companies are less risky than companies that lose money. That said, the current statutory profit is not always a good guide to a company's underlying profitability. Today we'll focus on whether this year's statutory profits are a good guide to understanding Care Twentyone (TYO:2373).

It's good to see that over the last twelve months Care Twentyone made a profit of JP¥711.0m on revenue of JP¥34.0b. While it managed to grow its revenue over the last three years, its profit has moved in the other direction, as you can see in the chart below.

Check out our latest analysis for Care Twentyone

Not all profits are equal, and we can learn more about the nature of a company's past profitability by diving deeper into the financial statements. So today we'll look at what Care Twentyone's cashflow tells us about the quality of its earnings. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Care Twentyone.

Examining Cashflow Against Care Twentyone'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. 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. The ratio shows us how much a company's profit exceeds its FCF.

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.

Care Twentyone has an accrual ratio of -0.21 for the year to October 2020. Therefore, its statutory earnings were very significantly less than its free cashflow. In fact, it had free cash flow of JP¥2.1b in the last year, which was a lot more than its statutory profit of JP¥711.0m. Care Twentyone's free cash flow improved over the last year, which is generally good to see.

Our Take On Care Twentyone's Profit Performance

Happily for shareholders, Care Twentyone produced plenty of free cash flow to back up its statutory profit numbers. Because of this, we think Care Twentyone's underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! Furthermore, it has done a great job growing EPS over the last year. The goal of this article has been to assess how well we can rely on the statutory earnings to reflect the company's potential, but there is plenty more to consider. In light of this, if you'd like to do more analysis on the company, it's vital to be informed of the risks involved. Our analysis shows 2 warning signs for Care Twentyone (1 makes us a bit uncomfortable!) and we strongly recommend you look at these bad boys before investing.

This note has only looked at a single factor that sheds light on the nature of Care Twentyone'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 that insiders are buying to be useful.

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This article by Simply Wall St is general in nature. 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.
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