Why Fuso ChemicalLtd's (TSE:4368) Shaky Earnings Are Just The Beginning Of Its Problems

The market wasn't impressed with the soft earnings from Fuso Chemical Co.,Ltd. (TSE:4368) recently. We did some further digging and think they have a few more reasons to be concerned beyond the statutory profit.

View our latest analysis for Fuso ChemicalLtd

Zooming In On Fuso ChemicalLtd'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. This ratio tells us how much of a company's profit is not backed by free cashflow.

Therefore, it's actually considered a good thing when a company has a negative accrual ratio, but a bad thing if its accrual ratio is positive. That is not intended to imply we should worry about a positive accrual ratio, but it's worth noting where the accrual ratio is rather high. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Fuso ChemicalLtd has an accrual ratio of 0.26 for the year to March 2024. 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¥11b, in contrast to the aforementioned profit of JP¥8.34b. We saw that FCF was JP¥291m a year ago though, so Fuso ChemicalLtd has at least been able to generate positive FCF in the past.

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 Fuso ChemicalLtd's Profit Performance

Fuso ChemicalLtd'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. Therefore, it seems possible to us that Fuso ChemicalLtd's true underlying earnings power is actually less than its statutory profit. But at least holders can take some solace from the 23% 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. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. Our analysis shows 3 warning signs for Fuso ChemicalLtd (1 is a bit concerning!) and we strongly recommend you look at these before investing.

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