We Think NCD's (TSE:4783) Robust Earnings Are Conservative

The subdued stock price reaction suggests that NCD Co., Ltd.'s (TSE:4783) strong earnings didn't offer any surprises. Our analysis suggests that investors might be missing some promising details.

View our latest analysis for NCD

Zooming In On NCD'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. 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. 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 March 2024, NCD recorded an accrual ratio of -0.61. Therefore, its statutory earnings were very significantly less than its free cashflow. In fact, it had free cash flow of JP¥2.3b in the last year, which was a lot more than its statutory profit of JP¥1.39b. Notably, NCD had negative free cash flow last year, so the JP¥2.3b 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 NCD.

Our Take On NCD's Profit Performance

Happily for shareholders, NCD produced plenty of free cash flow to back up its statutory profit numbers. Because of this, we think NCD's underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! Better yet, its EPS are growing strongly, which is nice to see. At the end of the day, it's essential to consider more than just the factors above, if you want to understand the company properly. If you'd like to know more about NCD as a business, it's important to be aware of any risks it's facing. At Simply Wall St, we found 2 warning signs for NCD and we think they deserve your attention.

This note has only looked at a single factor that sheds light on the nature of NCD's 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. 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.