Why Fast Retailing's (TSE:9983) Earnings Are Better Than They Seem

The stock was sluggish on the back of Fast Retailing Co., Ltd.'s (TSE:9983) recent earnings report. Along with the solid headline numbers, we think that investors have some reasons for optimism.

View our latest analysis for Fast Retailing

Examining Cashflow Against Fast Retailing's Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

For the year to February 2024, Fast Retailing had an accrual ratio of -0.27. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. Indeed, in the last twelve months it reported free cash flow of JP¥521b, well over the JP¥338.7b it reported in profit. Fast Retailing's free cash flow improved over the last year, which is generally good to see.

Our data indicates that Fast Retailing insiders have been buying shares! If you are like me, that'll make you wonder who exactly bought... and what price they paid! Soclick here to find out (using our intuitive visualisation of insider trading).

Our Take On Fast Retailing's Profit Performance

As we discussed above, Fast Retailing's accrual ratio indicates strong conversion of profit to free cash flow, which is a positive for the company. Because of this, we think Fast Retailing'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. 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. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. For example, we've discovered 1 warning sign that you should run your eye over to get a better picture of Fast Retailing.

This note has only looked at a single factor that sheds light on the nature of Fast Retailing's profit. 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. 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.