Investors Shouldn't Be Too Comfortable With Treasure FactoryLTD's (TSE:3093) Earnings

Unsurprisingly, Treasure Factory Co.,LTD.'s (TSE:3093) stock price was strong on the back of its healthy earnings report. However, our analysis suggests that shareholders may be missing some factors that indicate the earnings result was not as good as it looked.

Check out our latest analysis for Treasure FactoryLTD

A Closer Look At Treasure FactoryLTD'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. 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 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. 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 February 2024, Treasure FactoryLTD recorded an accrual ratio of 0.24. We can therefore deduce that its free cash flow fell well short of covering its statutory profit. In the last twelve months it actually had negative free cash flow, with an outflow of JP¥31m despite its profit of JP¥2.24b, mentioned above. It's worth noting that Treasure FactoryLTD generated positive FCF of JP¥980m a year ago, so at least they've done it in the past.

That might leave you wondering what analysts are forecasting in terms of future profitability. Luckily, you can click here to see an interactive graph depicting future profitability, based on their estimates.

Our Take On Treasure FactoryLTD's Profit Performance

Treasure FactoryLTD's accrual ratio for the last twelve months signifies cash conversion is less than ideal, which is a negative when it comes to our view of its earnings. Because of this, we think that it may be that Treasure FactoryLTD's statutory profits are better than its underlying earnings power. The good news is that, its earnings per share increased by 26% in the last year. 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. So while earnings quality is important, it's equally important to consider the risks facing Treasure FactoryLTD at this point in time. For example, Treasure FactoryLTD has 2 warning signs (and 1 which is a bit unpleasant) we think you should know about.

This note has only looked at a single factor that sheds light on the nature of Treasure FactoryLTD'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. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying.

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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.