Investors Can Find Comfort In Cybertrust Japan's (TSE:4498) Earnings Quality

Cybertrust Japan Co., Ltd.'s (TSE:4498) stock was strong despite it releasing a soft earnings report last week. Our analysis suggests that investors may have noticed some promising signs beyond the statutory profit figures.

See our latest analysis for Cybertrust Japan

Zooming In On Cybertrust Japan's Earnings

Many investors haven't heard of the accrual ratio from cashflow, but it is actually a useful measure of how well a company's profit is backed up by free cash flow (FCF) during a given period. 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.

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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

For the year to September 2024, Cybertrust Japan had an accrual ratio of -0.90. That indicates that its free cash flow quite significantly exceeded its statutory profit. To wit, it produced free cash flow of JP¥1.4b during the period, dwarfing its reported profit of JP¥645.0m. Cybertrust Japan's free cash flow improved over the last year, which is generally good to see. However, that's not all there is to consider. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio.

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

How Do Unusual Items Influence Profit?

Cybertrust Japan's profit was reduced by unusual items worth JP¥345m in the last twelve months, and this helped it produce high cash conversion, as reflected by its unusual items. This is what you'd expect to see where a company has a non-cash charge reducing paper profits. It's never great to see unusual items costing the company profits, but on the upside, things might improve sooner rather than later. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And that's hardly a surprise given these line items are considered unusual. Assuming those unusual expenses don't come up again, we'd therefore expect Cybertrust Japan to produce a higher profit next year, all else being equal.

Our Take On Cybertrust Japan's Profit Performance

In conclusion, both Cybertrust Japan's accrual ratio and its unusual items suggest that its statutory earnings are probably reasonably conservative. After considering all this, we reckon Cybertrust Japan's statutory profit probably understates its earnings potential! If you want to do dive deeper into Cybertrust Japan, you'd also look into what risks it is currently facing. For example, we've discovered 1 warning sign that you should run your eye over to get a better picture of Cybertrust Japan.

Our examination of Cybertrust Japan has focussed on certain factors that can make its earnings look better than they are. And it has passed with flying colours. 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.