Socionext's (TSE:6526) Conservative Accounting Might Explain Soft Earnings

Socionext Inc.'s (TSE:6526) earnings announcement last week didn't impress shareholders. However, our analysis suggests that the soft headline numbers are getting counterbalanced by some positive underlying factors.

Check out our latest analysis for Socionext

Examining Cashflow Against Socionext's Earnings

Many investors haven't heard of the accrual ratio from cashflow, but it is actually a useful measure of how well a company's profit is backed up by free cash flow (FCF) during a given period. 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'.

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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Socionext has an accrual ratio of -0.16 for the year to September 2024. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. In fact, it had free cash flow of JP¥33b in the last year, which was a lot more than its statutory profit of JP¥22.4b. Notably, Socionext had negative free cash flow last year, so the JP¥33b it produced this year was a welcome improvement.

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 Socionext's Profit Performance

Socionext's accrual ratio is solid, and indicates strong free cash flow, as we discussed, above. Based on this observation, we consider it likely that Socionext's statutory profit actually understates its earnings potential! And on top of that, its earnings per share have grown at an extremely impressive rate over the last three years. 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. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. When we did our research, we found 2 warning signs for Socionext (1 doesn't sit too well with us!) that we believe deserve your full attention.

Today we've zoomed in on a single data point to better understand the nature of Socionext'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. 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.