Should You Use NF Holdings's (TYO:6864) Statutory Earnings To Analyse It?

Statistically speaking, it is less risky to invest in profitable companies than in unprofitable ones. That said, the current statutory profit is not always a good guide to a company's underlying profitability. This article will consider whether NF Holdings' (TYO:6864) statutory profits are a good guide to its underlying earnings.

We like the fact that NF Holdings made a profit of JP¥780.0m on its revenue of JP¥11.8b, in the last year. One positive is that it has grown both its profit and its revenue, over the last few years, though not in the last twelve months.

See our latest analysis for NF Holdings

Of course, when it comes to statutory profit, the devil is often in the detail, and we can get a better sense for a company by diving deeper into the financial statements. Today, we'll discuss NF Holdings' free cashflow relative to its earnings, and consider what that tells us about the company. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of NF Holdings.

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

NF Holdings has an accrual ratio of 0.21 for the year to September 2020. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, which is hardly a good thing. Even though it reported a profit of JP¥780.0m, a look at free cash flow indicates it actually burnt through JP¥621m in the last year. It's worth noting that NF Holdings generated positive FCF of JP¥1.9b a year ago, so at least they've done it in the past. The good news for shareholders is that NF Holdings' accrual ratio was much better last year, so this year's poor reading might simply be a case of a short term mismatch between profit and FCF. Shareholders should look for improved cashflow relative to profit in the current year, if that is indeed the case.

Our Take On NF Holdings' Profit Performance

NF Holdings didn't convert much of its profit to free cash flow in the last year, which some investors may consider rather suboptimal. Because of this, we think that it may be that NF Holdings' statutory profits are better than its underlying earnings power. But on the bright side, its earnings per share have grown at an extremely impressive rate 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. If you want to do dive deeper into NF Holdings, you'd also look into what risks it is currently facing. When we did our research, we found 2 warning signs for NF Holdings (1 shouldn't be ignored!) that we believe deserve your full attention.

Today we've zoomed in on a single data point to better understand the nature of NF Holdings' 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.

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This article by Simply Wall St is general in nature. 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.
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