POPERLtd's (TSE:5134) Earnings Are Of Questionable Quality

Unsurprisingly, POPER Co.,Ltd.'s (TSE:5134) stock price was strong on the back of its healthy earnings report. However, we think that shareholders may be missing some concerning details in the numbers.

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Zooming In On POPERLtd's 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). The accrual ratio subtracts the FCF from the profit for a given period, and divides the result by the average operating assets of the company over that time. 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 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.

POPERLtd has an accrual ratio of 0.35 for the year to April 2025. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, raising questions about how useful that profit figure really is. Indeed, in the last twelve months it reported free cash flow of JP¥142m, which is significantly less than its profit of JP¥207.0m. Given that POPERLtd had negative free cash flow in the prior corresponding period, the trailing twelve month resul of JP¥142m would seem to be a step in the right direction. Importantly, we note an unusual tax situation, which we discuss below, has impacted the accruals ratio. This would certainly have contributed to the weak cash conversion.

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

An Unusual Tax Situation

In addition to the notable accrual ratio, we can see that POPERLtd received a tax benefit of JP¥40m. This is of course a bit out of the ordinary, given it is more common for companies to be paying tax than receiving tax benefits! Of course, prima facie it's great to receive a tax benefit. However, the devil in the detail is that these kind of benefits only impact in the year they are booked, and are often one-off in nature. In the likely event the tax benefit is not repeated, we'd expect to see its statutory profit levels drop, at least in the absence of strong growth. So while we think it's great to receive a tax benefit, it does tend to imply an increased risk that the statutory profit overstates the sustainable earnings power of the business.

Our Take On POPERLtd's Profit Performance

POPERLtd's accrual ratio indicates weak cashflow relative to earnings, which perhaps arises in part from the tax benefit it received this year. If the tax benefit is not repeated, then profit would drop next year, all else being equal. For the reasons mentioned above, we think that a perfunctory glance at POPERLtd's statutory profits might make it look better than it really is on an underlying level. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. Our analysis shows 3 warning signs for POPERLtd (2 are concerning!) and we strongly recommend you look at them before investing.

In this article we've looked at a number of factors that can impair the utility of profit numbers, and we've come away cautious. 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.