Nihon Falcom's (TSE:3723) Soft Earnings Don't Show The Whole Picture

Nihon Falcom Corporation's (TSE:3723) earnings announcement last week didn't impress shareholders. While the headline numbers were soft, we believe that investors might be missing some encouraging factors.

Check out our latest analysis for Nihon Falcom

Zooming In On Nihon Falcom'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). 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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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 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.

For the year to March 2024, Nihon Falcom had an accrual ratio of -0.51. Therefore, its statutory earnings were very significantly less than its free cashflow. In fact, it had free cash flow of JP¥992m in the last year, which was a lot more than its statutory profit of JP¥793.0m. Nihon Falcom shareholders are no doubt pleased that free cash flow improved over the last twelve months.

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

Our Take On Nihon Falcom's Profit Performance

As we discussed above, Nihon Falcom's accrual ratio indicates strong conversion of profit to free cash flow, which is a positive for the company. Based on this observation, we consider it possible that Nihon Falcom's statutory profit actually understates its earnings potential! On the other hand, its EPS actually shrunk in the last twelve months. 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. For instance, we've identified 2 warning signs for Nihon Falcom (1 can't be ignored) you should be familiar with.

Today we've zoomed in on a single data point to better understand the nature of Nihon Falcom'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 with significant insider holdings 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.