Shareholders Can Be Confident That Finatext Holdings' (TSE:4419) Earnings Are High Quality

When companies post strong earnings, the stock generally performs well, just like Finatext Holdings Ltd.'s (TSE:4419) stock has recently. We did some digging and found some further encouraging factors that investors will like.

See our latest analysis for Finatext Holdings

Zooming In On Finatext Holdings' 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). 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. 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 September 2024, Finatext Holdings recorded an accrual ratio of -0.31. 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¥520.0m. Given that Finatext Holdings had negative free cash flow in the prior corresponding period, the trailing twelve month resul of JP¥1.7b would seem to be a step in the right direction.

That might leave you wondering what analysts are forecasting in terms of future profitability. Luckily, you can click here to see an interactive graph depicting future profitability, based on their estimates.

Our Take On Finatext Holdings' Profit Performance

Happily for shareholders, Finatext Holdings produced plenty of free cash flow to back up its statutory profit numbers. Based on this observation, we consider it possible that Finatext Holdings' statutory profit actually understates its earnings potential! And it's also positive that the company showed enough improvement to book a profit this year, after losing money last year. 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 Finatext Holdings at this point in time. For example, we've discovered 2 warning signs that you should run your eye over to get a better picture of Finatext Holdings.

Today we've zoomed in on a single data point to better understand the nature of Finatext Holdings' profit. But there is always more to discover if you are capable of focussing your mind on minutiae. 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.