Aucfan's (TSE:3674) Solid Earnings Have Been Accounted For Conservatively

The stock was sluggish on the back of Aucfan Co., Ltd.'s (TSE:3674) recent earnings report. Our analysis suggests that there are some reasons for hope that investors should be aware of.

Check out our latest analysis for Aucfan

A Closer Look At Aucfan'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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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".

Aucfan has an accrual ratio of -0.29 for the year to September 2024. Therefore, its statutory earnings were very significantly less than its free cashflow. To wit, it produced free cash flow of JP¥790m during the period, dwarfing its reported profit of JP¥187.0m. Notably, Aucfan had negative free cash flow last year, so the JP¥790m it produced this year was a welcome improvement. Having said that, there is more to the story. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part.

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

The Impact Of Unusual Items On Profit

Aucfan's profit was reduced by unusual items worth JP¥51m 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 that's hardly a surprise given these line items are considered unusual. Assuming those unusual expenses don't come up again, we'd therefore expect Aucfan to produce a higher profit next year, all else being equal.

Our Take On Aucfan's Profit Performance

In conclusion, both Aucfan's accrual ratio and its unusual items suggest that its statutory earnings are probably reasonably conservative. Based on these factors, we think Aucfan's underlying earnings potential is as good as, or probably even better, than the statutory profit makes it seem! If you'd like to know more about Aucfan as a business, it's important to be aware of any risks it's facing. To that end, you should learn about the 2 warning signs we've spotted with Aucfan (including 1 which is potentially serious).

After our examination into the nature of Aucfan's profit, we've come away optimistic for the company. But there is always more to discover if you are capable of focussing your mind on minutiae. Some people consider a high return on equity to be a good sign of a quality business. 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.