Double Standard's (TSE:3925) Solid Earnings May Rest On Weak Foundations

Double Standard Inc.'s (TSE:3925) robust recent earnings didn't do much to move the stock. We believe that shareholders have noticed some concerning factors beyond the statutory profit numbers.

Check out our latest analysis for Double Standard

A Closer Look At Double Standard'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. 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.

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

Over the twelve months to March 2024, Double Standard recorded an accrual ratio of 0.77. 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. To wit, it produced free cash flow of JP¥1.0b during the period, falling well short of its reported profit of JP¥1.65b. Double Standard'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 Double Standard.

Our Take On Double Standard's Profit Performance

As we have made quite clear, we're a bit worried that Double Standard didn't back up the last year's profit with free cashflow. As a result, we think it may well be the case that Double Standard's underlying earnings power is lower than its statutory profit. But on the bright side, its earnings per share have grown at an extremely impressive rate 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. In light of this, if you'd like to do more analysis on the company, it's vital to be informed of the risks involved. For instance, we've identified 2 warning signs for Double Standard (1 makes us a bit uncomfortable) you should be familiar with.

This note has only looked at a single factor that sheds light on 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. 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.