CEL's (TSE:5078) Solid Profits Have Weak Fundamentals

Investors were disappointed with CEL Corporation's (TSE:5078) earnings, despite the strong profit numbers. We think that the market might be paying attention to some underlying factors that they find to be concerning.

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Zooming In On CEL'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. The ratio shows us how much a company's profit exceeds its FCF.

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. That is not intended to imply we should worry about a positive accrual ratio, but it's worth noting where the accrual ratio is rather high. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

CEL has an accrual ratio of 0.54 for the year to August 2025. 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. Over the last year it actually had negative free cash flow of JP¥86m, in contrast to the aforementioned profit of JP¥1.32b. We saw that FCF was JP¥84m a year ago though, so CEL 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 CEL.

Our Take On CEL's Profit Performance

As we discussed above, we think CEL's earnings were not supported by free cash flow, which might concern some investors. For this reason, we think that CEL's statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. But at least holders can take some solace from the 6.5% EPS growth in the last year. At the end of the day, it's essential to consider more than just the factors above, if you want to understand the company properly. If you want to do dive deeper into CEL, you'd also look into what risks it is currently facing. Be aware that CEL is showing 3 warning signs in our investment analysis and 2 of those can't be ignored...

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