Investors Shouldn't Be Too Comfortable With Pacific NetLtd's (TSE:3021) Earnings

Despite announcing strong earnings, Pacific Net Co.,Ltd.'s (TSE:3021) stock was sluggish. We did some digging and found some worrying underlying problems.

See our latest analysis for Pacific NetLtd

A Closer Look At Pacific NetLtd'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. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that 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. 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Over the twelve months to May 2024, Pacific NetLtd recorded an accrual ratio of 0.32. We can therefore deduce that its free cash flow fell well short of covering its statutory profit, suggesting we might want to think twice before putting a lot of weight on the latter. Over the last year it actually had negative free cash flow of JP¥1.8b, in contrast to the aforementioned profit of JP¥432.0m. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of JP¥1.8b, this year, indicates high risk.

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

Our Take On Pacific NetLtd's Profit Performance

As we have made quite clear, we're a bit worried that Pacific NetLtd didn't back up the last year's profit with free cashflow. As a result, we think it may well be the case that Pacific NetLtd's underlying earnings power is lower than its statutory profit. The good news is that, its earnings per share increased by 26% in the last year. 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. In light of this, if you'd like to do more analysis on the company, it's vital to be informed of the risks involved. Our analysis shows 6 warning signs for Pacific NetLtd (1 makes us a bit uncomfortable!) and we strongly recommend you look at them before investing.

This note has only looked at a single factor that sheds light on the nature of Pacific NetLtd's profit. But there is always more to discover if you are capable of focussing your mind on minutiae. 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. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com