Daiichi Sankyo Company's (TSE:4568) Solid Earnings Are Supported By Other Strong Factors

The subdued stock price reaction suggests that Daiichi Sankyo Company, Limited's (TSE:4568) strong earnings didn't offer any surprises. Investors are probably missing some underlying factors which are encouraging for the future of the company.

Check out our latest analysis for Daiichi Sankyo Company

Examining Cashflow Against Daiichi Sankyo Company'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. 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.

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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

For the year to September 2024, Daiichi Sankyo Company had an accrual ratio of -0.16. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. In fact, it had free cash flow of JP¥417b in the last year, which was a lot more than its statutory profit of JP¥250.4b. Given that Daiichi Sankyo Company had negative free cash flow in the prior corresponding period, the trailing twelve month resul of JP¥417b would seem to be a step in the right direction.

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 Daiichi Sankyo Company's Profit Performance

As we discussed above, Daiichi Sankyo Company has perfectly satisfactory free cash flow relative to profit. Based on this observation, we consider it likely that Daiichi Sankyo Company's statutory profit actually understates its earnings potential! Better yet, its EPS are growing strongly, which is nice to see. Of course, we've only just scratched the surface when it comes to analysing its earnings; one could also consider margins, forecast growth, and return on investment, among other factors. Obviously, we love to consider the historical data to inform our opinion of a company. But it can be really valuable to consider what other analysts are forecasting. At Simply Wall St, we have analyst estimates which you can view by clicking here.

Today we've zoomed in on a single data point to better understand the nature of Daiichi Sankyo Company'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. 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.