We Think That There Are Issues Underlying DM SolutionsLtd's (TSE:6549) Earnings

DM Solutions Co.,Ltd's (TSE:6549) robust earnings report didn't manage to move the market for its stock. Our analysis suggests that shareholders have noticed something concerning in the numbers.

View our latest analysis for DM SolutionsLtd

Examining Cashflow Against DM SolutionsLtd'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. 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.

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 March 2024, DM SolutionsLtd recorded an accrual ratio of 0.57. Statistically speaking, that's a real negative for future earnings. And indeed, during the period the company didn't produce any free cash flow whatsoever. Over the last year it actually had negative free cash flow of JP¥1.3b, in contrast to the aforementioned profit of JP¥402.0m. It's worth noting that DM SolutionsLtd generated positive FCF of JP¥523m a year ago, so at least they've done it in the past. One positive for DM SolutionsLtd shareholders is that it's accrual ratio was significantly better last year, providing reason to believe that it may return to stronger cash conversion in the future. As a result, some shareholders may be looking for stronger cash conversion in the current year.

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

Our Take On DM SolutionsLtd's Profit Performance

As we discussed above, we think DM SolutionsLtd's earnings were not supported by free cash flow, which might concern some investors. As a result, we think it may well be the case that DM SolutionsLtd's underlying earnings power is lower than its statutory profit. But on the bright side, its earnings per share have grown at an extremely impressive rate over the last three years. 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. So while earnings quality is important, it's equally important to consider the risks facing DM SolutionsLtd at this point in time. Be aware that DM SolutionsLtd is showing 2 warning signs in our investment analysis and 1 of those is significant...

Today we've zoomed in on a single data point to better understand the nature of DM SolutionsLtd's profit. But there is always more to discover if you are capable of focussing your mind on minutiae. 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.