Pack's (TSE:3950) Solid Profits Have Weak Fundamentals

The Pack Corporation (TSE:3950) announced strong profits, but the stock was stagnant. Our analysis suggests that shareholders have noticed something concerning in the numbers.

See our latest analysis for Pack

Zooming In On Pack's Earnings

As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. 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.

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.

For the year to December 2023, Pack had an accrual ratio of 0.20. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, which is hardly a good thing. Over the last year it actually had negative free cash flow of JP¥2.8b, in contrast to the aforementioned profit of JP¥5.65b. It's worth noting that Pack generated positive FCF of JP¥1.8b a year ago, so at least they've done it in the past.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Pack.

Our Take On Pack's Profit Performance

Pack'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 Pack's statutory profits are better than its underlying earnings power. But on the bright side, its earnings per share have grown at an extremely impressive rate over the last three years. 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. So while earnings quality is important, it's equally important to consider the risks facing Pack at this point in time. For example, Pack has 3 warning signs (and 2 which are concerning) we think you should know about.

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