Material Group's (TSE:156A) Earnings Offer More Than Meets The Eye

Despite posting healthy earnings, Material Group Inc.'s (TSE:156A ) stock has been quite weak. Along with the solid headline numbers, we think that investors have some reasons for optimism.

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A Closer Look At Material Group'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. 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. 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Over the twelve months to February 2025, Material Group recorded an accrual ratio of -0.18. Therefore, its statutory earnings were very significantly less than its free cashflow. In fact, it had free cash flow of JP¥892m in the last year, which was a lot more than its statutory profit of JP¥672.0m. Unfortunately, we don't have data on Material Group's free cash flow for the prior year; that's not necessarily a bad thing, though we do generally prefer to be able to see a bit of a company's history.

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

Our Take On Material Group's Profit Performance

Happily for shareholders, Material Group produced plenty of free cash flow to back up its statutory profit numbers. Based on this observation, we consider it possible that Material Group's statutory profit actually understates its earnings potential! And on top of that, its earnings per share increased by 19% in 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. In terms of investment risks, we've identified 2 warning signs with Material Group, and understanding these should be part of your investment process.

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