We Think That There Are More Issues For System ResearchLtd (TSE:3771) Than Just Sluggish Earnings

System Research Co.,Ltd.'s (TSE:3771) stock showed strength, with investors undeterred by its weak earnings report. We think that shareholders might be missing some concerning factors that our analysis found.

See our latest analysis for System ResearchLtd

Examining Cashflow Against System ResearchLtd'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). 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. That is not intended to imply we should worry about a positive accrual ratio, but it's worth noting where the accrual ratio is rather high. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

System ResearchLtd has an accrual ratio of 0.26 for the year to September 2024. Unfortunately, that means its free cash flow fell significantly short of its reported profits. To wit, it produced free cash flow of JP¥949m during the period, falling well short of its reported profit of JP¥1.97b. System ResearchLtd shareholders will no doubt be hoping that its free cash flow bounces back next year, since it was down over the last twelve months.

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

Our Take On System ResearchLtd's Profit Performance

System ResearchLtd 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 System ResearchLtd's statutory profits are better than its underlying earnings power. But at least holders can take some solace from the 60% per annum growth in EPS for the last three. The goal of this article has been to assess how well we can rely on the statutory earnings to reflect the company's potential, but there is plenty more to consider. If you want to do dive deeper into System ResearchLtd, you'd also look into what risks it is currently facing. Every company has risks, and we've spotted 1 warning sign for System ResearchLtd you should know about.

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