Solid Earnings May Not Tell The Whole Story For AXELL (TSE:6730)

The stock price didn't jump after AXELL Corporation (TSE:6730) posted decent earnings last week. Our analysis showed that there are some concerning factors in the earnings that investors may be cautious of.

Check out our latest analysis for AXELL

A Closer Look At AXELL'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. This ratio tells us how much of a company's profit is not backed by free cashflow.

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.

Over the twelve months to March 2024, AXELL recorded an accrual ratio of 0.62. Ergo, its free cash flow is significantly weaker than its profit. As a general rule, that bodes poorly for future profitability. To wit, it produced free cash flow of JP¥523m during the period, falling well short of its reported profit of JP¥1.77b. AXELL shareholders will no doubt be hoping that its free cash flow bounces back next year, since it was down over the last twelve months. The good news for shareholders is that AXELL's accrual ratio was much better last year, so this year's poor reading might simply be a case of a short term mismatch between profit and FCF. Shareholders should look for improved cashflow relative to profit in the current year, if that is indeed the case.

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

Our Take On AXELL's Profit Performance

As we have made quite clear, we're a bit worried that AXELL didn't back up the last year's profit with free cashflow. For this reason, we think that AXELL's statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. But the good news is that its EPS growth over the last three years has been very impressive. 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. If you'd like to know more about AXELL as a business, it's important to be aware of any risks it's facing. Be aware that AXELL is showing 4 warning signs in our investment analysis and 1 of those shouldn't be ignored...

This note has only looked at a single factor that sheds light on the nature of AXELL's profit. But there are plenty of other ways to inform your opinion of a company. 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. 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.