We Think You Should Be Aware Of Some Concerning Factors In Japan Electronic Materials' (TSE:6855) Earnings

Japan Electronic Materials Corporation's (TSE:6855 ) stock didn't jump after it announced some healthy earnings. Our analysis showed that there are some concerning factors in the earnings that investors may be cautious of.

View our latest analysis for Japan Electronic Materials

Examining Cashflow Against Japan Electronic Materials' 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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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 having an accrual ratio above zero is of little concern, we do think it's worth noting when a company has a relatively high accrual ratio. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Japan Electronic Materials has an accrual ratio of 0.23 for the year to September 2024. We can therefore deduce that its free cash flow fell well short of covering its statutory profit. Over the last year it actually had negative free cash flow of JP¥2.0b, in contrast to the aforementioned profit of JP¥1.89b. It's worth noting that Japan Electronic Materials generated positive FCF of JP¥3.2b a year ago, so at least they've done it in the past. The good news for shareholders is that Japan Electronic Materials' 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.

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 Japan Electronic Materials' Profit Performance

Japan Electronic Materials didn't convert much of its profit to free cash flow in the last year, which some investors may consider rather suboptimal. Because of this, we think that it may be that Japan Electronic Materials' statutory profits are better than its underlying earnings power. The good news is that, its earnings per share increased by 17% in the last year. 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. To that end, you should learn about the 3 warning signs we've spotted with Japan Electronic Materials (including 2 which are potentially serious).

This note has only looked at a single factor that sheds light on the nature of Japan Electronic Materials' 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. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks with high insider ownership.

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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.