We Think IPS' (TYO:4335) Statutory Profit Might Understate Its Earnings Potential

It might be old fashioned, but we really like to invest in companies that make a profit, each and every year. 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 IPS (TYO:4335).

It's good to see that over the last twelve months IPS made a profit of JP¥155.0m on revenue of JP¥2.68b.

See our latest analysis for IPS

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. So today we'll look at what IPS' cashflow tells us about the quality of its earnings. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of IPS.

A Closer Look At IPS' 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. 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 December 2020, IPS recorded an accrual ratio of -1.04. That indicates that its free cash flow quite significantly exceeded its statutory profit. In fact, it had free cash flow of JP¥632m in the last year, which was a lot more than its statutory profit of JP¥155.0m. Notably, IPS had negative free cash flow last year, so the JP¥632m it produced this year was a welcome improvement.

Our Take On IPS' Profit Performance

Happily for shareholders, IPS produced plenty of free cash flow to back up its statutory profit numbers. Based on this observation, we consider it possible that IPS' statutory profit actually understates its earnings potential! And the EPS is up 66% over the last twelve months. 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. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. For example, IPS has 2 warning signs (and 1 which makes us a bit uncomfortable) we think you should know about.

Today we've zoomed in on a single data point to better understand the nature of IPS' 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 that insiders are buying to be useful.

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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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