Shareholders Can Be Confident That NEOJAPAN's (TSE:3921) Earnings Are High Quality

Even though NEOJAPAN Inc. (TSE:3921 ) posted strong earnings, investors appeared to be underwhelmed. We did some digging and actually think they are being unnecessarily pessimistic.

View our latest analysis for NEOJAPAN

A Closer Look At NEOJAPAN'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. To get the accrual ratio we first subtract FCF from profit for a period, and then divide that number by the average operating assets for the period. The ratio shows us how much a company's profit exceeds its FCF.

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.

For the year to January 2025, NEOJAPAN had an accrual ratio of -0.39. That indicates that its free cash flow quite significantly exceeded its statutory profit. In fact, it had free cash flow of JP¥1.7b in the last year, which was a lot more than its statutory profit of JP¥1.41b. NEOJAPAN shareholders are no doubt pleased that free cash flow improved 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 NEOJAPAN.

Our Take On NEOJAPAN's Profit Performance

Happily for shareholders, NEOJAPAN produced plenty of free cash flow to back up its statutory profit numbers. Because of this, we think NEOJAPAN's underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! And on top of that, its earnings per share have grown at an extremely impressive rate over the last three years. 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. While it's very important to consider the profit and loss statement, you can also learn a lot about a company by looking at its balance sheet. You can see our latest analysis on NEOJAPAN's balance sheet health here.

This note has only looked at a single factor that sheds light on the nature of NEOJAPAN'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. 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.