Are Naigai Tec's (TYO:3374) Statutory Earnings A Good Reflection Of Its Earnings Potential?

As a general rule, we think profitable companies are less risky than companies that lose money. Having said that, sometimes statutory profit levels are not a good guide to ongoing profitability, because some short term one-off factor has impacted profit levels. In this article, we'll look at how useful this year's statutory profit is, when analysing Naigai Tec (TYO:3374).

It's good to see that over the last twelve months Naigai Tec made a profit of JP¥530.0m on revenue of JP¥25.2b. As you can see in the chart below, its profit has declined over the last three years, even though its revenue has increased.

See our latest analysis for Naigai Tec

Importantly, statutory profits are not always the best tool for understanding a company's true earnings power, so it's well worth examining profits in a little more detail. As a result, we think it's well worth considering what Naigai Tec's cashflow (when compared to its earnings) can tell us about the nature of its statutory profit. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Naigai Tec.

Examining Cashflow Against Naigai Tec'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. 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. The ratio shows us how much a company's profit exceeds its FCF.

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".

For the year to September 2020, Naigai Tec had an accrual ratio of -0.10. That indicates that its free cash flow was a fair bit more than its statutory profit. Indeed, in the last twelve months it reported free cash flow of JP¥933m, well over the JP¥530.0m it reported in profit. Given that Naigai Tec had negative free cash flow in the prior corresponding period, the trailing twelve month resul of JP¥933m would seem to be a step in the right direction.

Our Take On Naigai Tec's Profit Performance

Naigai Tec's accrual ratio is solid, and indicates strong free cash flow, as we discussed, above. Because of this, we think Naigai Tec's earnings potential is at least as good as it seems, and maybe even better! And on top of that, its earnings per share have grown at an extremely impressive rate over the last year. 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 Naigai Tec at this point in time. For example, Naigai Tec has 3 warning signs (and 1 which is concerning) we think you should know about.

This note has only looked at a single factor that sheds light on the nature of Naigai Tec'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 that insiders are buying.

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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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