Solid Earnings May Not Tell The Whole Story For FAN Communications (TSE:2461)

The recent earnings posted by FAN Communications, Inc. (TSE:2461) were solid, but the stock didn't move as much as we expected. We think this is due to investors looking beyond the statutory profits and being concerned with what they see.

Check out our latest analysis for FAN Communications

Examining Cashflow Against FAN Communications' 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.

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. 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 June 2024, FAN Communications had an accrual ratio of 1.07. Ergo, its free cash flow is significantly weaker than its profit. Statistically speaking, that's a real negative for future earnings. In fact, it had free cash flow of JP¥921m in the last year, which was a lot less than its statutory profit of JP¥1.46b. FAN Communications' free cash flow actually declined over the last year, but it may bounce back next year, since free cash flow is often more volatile than accounting profits. The good news for shareholders is that FAN Communications' accrual ratio was much better last year, so this year's poor reading might simply be a case of a short term mismatch between profit and FCF. As a result, some shareholders may be looking for stronger cash conversion in the current year.

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 FAN Communications' Profit Performance

As we have made quite clear, we're a bit worried that FAN Communications didn't back up the last year's profit with free cashflow. As a result, we think it may well be the case that FAN Communications' underlying earnings power is lower than its statutory profit. But at least holders can take some solace from the 17% EPS growth in the last year. 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. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. For example, we've found that FAN Communications has 3 warning signs (2 shouldn't be ignored!) that deserve your attention before going any further with your analysis.

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