Should You Rely On Jason's (TYO:3080) Earnings Growth?

Many investors consider it preferable to invest in profitable companies over unprofitable ones, because profitability suggests a business is sustainable. That said, the current statutory profit is not always a good guide to a company's underlying profitability. This article will consider whether Jason's (TYO:3080) statutory profits are a good guide to its underlying earnings.

While Jason was able to generate revenue of JP¥26.3b in the last twelve months, we think its profit result of JP¥786.0m was more important. In the chart below, you can see that its profit and revenue have both grown over the last three years.

See our latest analysis for Jason

Of course, it is only sensible to look beyond the statutory profits and question how well those numbers represent the sustainable earnings power of the business. So today we'll look at what Jason's cashflow tells us about the quality of its earnings. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Jason.

Zooming In On Jason's Earnings

As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. 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. The ratio shows us how much a company's profit exceeds its FCF.

Therefore, it's actually considered a good thing when a company has a negative accrual ratio, but a bad thing if its accrual ratio is positive. 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".

Over the twelve months to August 2020, Jason recorded an accrual ratio of -0.21. Therefore, its statutory earnings were very significantly less than its free cashflow. In fact, it had free cash flow of JP¥1.1b in the last year, which was a lot more than its statutory profit of JP¥786.0m. Jason shareholders are no doubt pleased that free cash flow improved over the last twelve months.

Our Take On Jason's Profit Performance

As we discussed above, Jason's accrual ratio indicates strong conversion of profit to free cash flow, which is a positive for the company. Because of this, we think Jason's underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! Better yet, its EPS are growing strongly, which is nice to see. 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. So while earnings quality is important, it's equally important to consider the risks facing Jason at this point in time. While conducting our analysis, we found that Jason has 2 warning signs and it would be unwise to ignore these.

Today we've zoomed in on a single data point to better understand the nature of Jason'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 that insiders are buying to be useful.

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This article by Simply Wall St is general in nature. 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.
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