We Think That There Are More Issues For Systems Design (TSE:3766) Than Just Sluggish Earnings

The market rallied behind Systems Design Co., Ltd.'s (TSE:3766) stock, leading do a rise in the share price after its recent weak earnings report. Sometimes, shareholders are willing to ignore soft numbers with the hope that they will improve, but our analysis suggests this is unlikely for Systems Design.

Our free stock report includes 3 warning signs investors should be aware of before investing in Systems Design. Read for free now.

Zooming In On Systems Design's 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. The ratio shows us how much a company's profit exceeds its FCF.

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".

Over the twelve months to March 2025, Systems Design recorded an accrual ratio of 0.21. 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¥6.0m, in contrast to the aforementioned profit of JP¥297.0m. We saw that FCF was JP¥849m a year ago though, so Systems Design has at least been able to generate positive FCF in the past. The good news for shareholders is that Systems Design'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. As a result, some shareholders may be looking for stronger cash conversion in the current year.

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

Our Take On Systems Design's Profit Performance

Systems Design's accrual ratio for the last twelve months signifies cash conversion is less than ideal, which is a negative when it comes to our view of its earnings. Because of this, we think that it may be that Systems Design's statutory profits are better than its underlying earnings power. But at least holders can take some solace from the 24% 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 Systems Design, you'd also look into what risks it is currently facing. Our analysis shows 3 warning signs for Systems Design (1 doesn't sit too well with us!) and we strongly recommend you look at them before investing.

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