We Think That There Are More Issues For Sobal (TSE:2186) Than Just Sluggish Earnings

The subdued market reaction suggests that Sobal Corporation's (TSE:2186) recent earnings didn't contain any surprises. We think that investors are worried about some weaknesses underlying the earnings.

Check out our latest analysis for Sobal

Examining Cashflow Against Sobal's Earnings

In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). 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'.

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 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. 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 February 2024, Sobal recorded an accrual ratio of 0.43. That means it didn't generate anywhere near enough free cash flow to match its profit. Statistically speaking, that's a real negative for future earnings. Indeed, in the last twelve months it reported free cash flow of JP¥78m, which is significantly less than its profit of JP¥513.0m. Sobal's free cash flow actually declined over the last year, but it may bounce back next year, since free cash flow is often more volatile than accounting profits.

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

Our Take On Sobal's Profit Performance

As we have made quite clear, we're a bit worried that Sobal didn't back up the last year's profit with free cashflow. For this reason, we think that Sobal'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 at least holders can take some solace from the 36% per annum growth in EPS for the last three. 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. If you want to do dive deeper into Sobal, you'd also look into what risks it is currently facing. For instance, we've identified 3 warning signs for Sobal (1 is a bit concerning) you should be familiar with.

Today we've zoomed in on a single data point to better understand the nature of Sobal's profit. But there is always more to discover if you are capable of focussing your mind on minutiae. Some people consider a high return on equity to be a good sign of a quality business. 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. 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.