We Like The Quality Of Grandy House's (TSE:8999) Earnings

Despite posting healthy earnings, Grandy House Corporation's (TSE:8999 ) stock has been quite weak. We have done some analysis, and found some encouraging factors that we believe the shareholders should consider.

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Examining Cashflow Against Grandy House'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. To get the accrual ratio we first subtract FCF from profit for a period, and then divide that number by the average operating assets for the 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Grandy House has an accrual ratio of -0.14 for the year to March 2025. That indicates that its free cash flow quite significantly exceeded its statutory profit. To wit, it produced free cash flow of JP¥8.3b during the period, dwarfing its reported profit of JP¥486.0m. Given that Grandy House had negative free cash flow in the prior corresponding period, the trailing twelve month resul of JP¥8.3b would seem to be a step in the right direction. However, that's not all there is to consider. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio.

View our latest analysis for Grandy House

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

The Impact Of Unusual Items On Profit

Grandy House's profit was reduced by unusual items worth JP¥154m in the last twelve months, and this helped it produce high cash conversion, as reflected by its unusual items. This is what you'd expect to see where a company has a non-cash charge reducing paper profits. It's never great to see unusual items costing the company profits, but on the upside, things might improve sooner rather than later. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And, after all, that's exactly what the accounting terminology implies. Assuming those unusual expenses don't come up again, we'd therefore expect Grandy House to produce a higher profit next year, all else being equal.

Our Take On Grandy House's Profit Performance

In conclusion, both Grandy House's accrual ratio and its unusual items suggest that its statutory earnings are probably reasonably conservative. Looking at all these factors, we'd say that Grandy House's underlying earnings power is at least as good as the statutory numbers would make it seem. So while earnings quality is important, it's equally important to consider the risks facing Grandy House at this point in time. Case in point: We've spotted 3 warning signs for Grandy House you should be mindful of and 2 of them can't be ignored.

After our examination into the nature of Grandy House's profit, we've come away optimistic for the company. 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.