Why Nihon Falcom's (TSE:3723) Earnings Are Better Than They Seem

Despite posting healthy earnings, Nihon Falcom Corporation's (TSE:3723 ) stock has been quite weak. Along with the solid headline numbers, we think that investors have some reasons for optimism.

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Zooming In On Nihon Falcom's 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. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Over the twelve months to September 2025, Nihon Falcom recorded an accrual ratio of -0.19. Therefore, its statutory earnings were very significantly less than its free cashflow. In fact, it had free cash flow of JP¥1.0b in the last year, which was a lot more than its statutory profit of JP¥903.0m. 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! And on top of that, its earnings per share increased by 6.0% 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. When we did our research, we found 3 warning signs for Nihon Falcom (2 are potentially serious!) that we believe deserve your full attention.

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. 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.