Double Standard's (TSE:3925) Promising Earnings May Rest On Soft Foundations

Double Standard Inc. (TSE:3925) announced strong profits, but the stock was stagnant. Our analysis suggests that shareholders have noticed something concerning in the numbers.

View our latest analysis for Double Standard

Examining Cashflow Against Double Standard's Earnings

As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. 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'.

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 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

For the year to September 2024, Double Standard had an accrual ratio of 0.24. We can therefore deduce that its free cash flow fell well short of covering its statutory profit. Indeed, in the last twelve months it reported free cash flow of JP¥1.6b, which is significantly less than its profit of JP¥1.82b. At this point we should mention that Double Standard did manage to increase its free cash flow in the last twelve months

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

Our Take On Double Standard's Profit Performance

Double Standard 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 Double Standard's statutory profits are better than its underlying earnings power. Nonetheless, it's still worth noting that its earnings per share have grown at 59% over the last three years. 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. So while earnings quality is important, it's equally important to consider the risks facing Double Standard at this point in time. Every company has risks, and we've spotted 1 warning sign for Double Standard you should know about.

Today we've zoomed in on a single data point to better understand the nature of Double Standard's profit. But there are plenty of other ways to inform your opinion of a company. For example, many people consider a high return on equity as an indication of favorable business economics, while others like to 'follow the money' and search out stocks that insiders are buying. 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.