Shareholders Will Be Pleased With The Quality of Ryoyu Systems' (TSE:4685) Earnings

Ryoyu Systems Co., Ltd. (TSE:4685) recently posted some strong earnings, and the market responded positively. Our analysis found some more factors that we think are good for shareholders.

View our latest analysis for Ryoyu Systems

Examining Cashflow Against Ryoyu Systems' 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. This ratio tells us how much of a company's profit is not backed by free cashflow.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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".

Ryoyu Systems has an accrual ratio of -0.13 for the year to March 2024. That indicates that its free cash flow was a fair bit more than its statutory profit. Indeed, in the last twelve months it reported free cash flow of JP¥3.4b, well over the JP¥2.42b it reported in profit. Notably, Ryoyu Systems had negative free cash flow last year, so the JP¥3.4b it produced this year was a welcome improvement.

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

Our Take On Ryoyu Systems' Profit Performance

As we discussed above, Ryoyu Systems has perfectly satisfactory free cash flow relative to profit. Based on this observation, we consider it likely that Ryoyu Systems' statutory profit actually understates its earnings potential! And the EPS is up 70% annually, over the last three years. The goal of this article has been to assess how well we can rely on the statutory earnings to reflect the company's potential, but there is plenty more to consider. While earnings are important, another area to consider is the balance sheet. You can see our latest analysis on Ryoyu Systems' balance sheet health here.

This note has only looked at a single factor that sheds light on the nature of Ryoyu Systems' profit. But there is always more to discover if you are capable of focussing your mind on minutiae. 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 that insiders are buying to be useful.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.