Does Hoshi Iryo-Sanki's (TYO:7634) Statutory Profit Adequately Reflect Its Underlying Profit?

It might be old fashioned, but we really like to invest in companies that make a profit, each and every year. 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 Hoshi Iryo-Sanki (TYO:7634).

We like the fact that Hoshi Iryo-Sanki made a profit of JP¥690.0m on its revenue of JP¥11.0b, in the last year. The chart below shows how it has grown revenue over the last three years, but that profit has declined.

Check out our latest analysis for Hoshi Iryo-Sanki

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. As a result, we think it's well worth considering what Hoshi Iryo-Sanki's cashflow (when compared to its earnings) can tell us about the nature of its statutory profit. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Hoshi Iryo-Sanki.

Zooming In On Hoshi Iryo-Sanki'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. 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.

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

Over the twelve months to September 2020, Hoshi Iryo-Sanki recorded an accrual ratio of -0.17. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. To wit, it produced free cash flow of JP¥1.5b during the period, dwarfing its reported profit of JP¥690.0m. Hoshi Iryo-Sanki's free cash flow improved over the last year, which is generally good to see.

Our Take On Hoshi Iryo-Sanki's Profit Performance

Happily for shareholders, Hoshi Iryo-Sanki produced plenty of free cash flow to back up its statutory profit numbers. Because of this, we think Hoshi Iryo-Sanki's underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! Unfortunately, though, its earnings per share actually fell back over 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. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. For example - Hoshi Iryo-Sanki has 1 warning sign we think you should be aware of.

This note has only looked at a single factor that sheds light on the nature of Hoshi Iryo-Sanki's profit. But there are plenty of other ways to inform your opinion of a company. 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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