Weak Statutory Earnings May Not Tell The Whole Story For Dear LifeLtd (TSE:3245)

Dear Life Co.,Ltd.'s (TSE:3245) stock showed strength, with investors undeterred by its weak earnings report. Sometimes, shareholders are willing to ignore soft numbers with the hope that they will improve, but our analysis suggests this is unlikely for Dear LifeLtd.

Check out our latest analysis for Dear LifeLtd

A Closer Look At Dear LifeLtd'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). 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 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

For the year to September 2024, Dear LifeLtd had an accrual ratio of 0.44. As a general rule, that bodes poorly for future profitability. And indeed, during the period the company didn't produce any free cash flow whatsoever. Even though it reported a profit of JP¥3.17b, a look at free cash flow indicates it actually burnt through JP¥6.0b in the last year. We saw that FCF was JP¥1.3b a year ago though, so Dear LifeLtd has at least been able to generate positive FCF in the past.

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

Our Take On Dear LifeLtd's Profit Performance

As we discussed above, we think Dear LifeLtd's earnings were not supported by free cash flow, which might concern some investors. For this reason, we think that Dear LifeLtd's statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. Sadly, its EPS was down over 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. If you want to do dive deeper into Dear LifeLtd, you'd also look into what risks it is currently facing. To that end, you should learn about the 3 warning signs we've spotted with Dear LifeLtd (including 1 which is a bit unpleasant).

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