Impressive Earnings May Not Tell The Whole Story For Tomen Devices (TSE:2737)

Tomen Devices Corporation (TSE:2737) just reported some strong earnings, and the market reacted accordingly with a healthy uplift in the share price. However, we think that shareholders may be missing some concerning details in the numbers.

See our latest analysis for Tomen Devices

A Closer Look At Tomen Devices' 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. That is not intended to imply we should worry about a positive accrual ratio, but it's worth noting where the accrual ratio is rather high. 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, Tomen Devices had an accrual ratio of 0.55. As a general rule, that bodes poorly for future profitability. To wit, the company did not generate one whit of free cashflow in that time. In the last twelve months it actually had negative free cash flow, with an outflow of JP¥28b despite its profit of JP¥6.12b, mentioned above. It's worth noting that Tomen Devices generated positive FCF of JP¥53b a year ago, so at least they've done it in the past. One positive for Tomen Devices shareholders is that it's accrual ratio was significantly better last year, providing reason to believe that it may return to stronger cash conversion in the future. As a result, some shareholders may be looking for stronger cash conversion in the current year.

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

Our Take On Tomen Devices' Profit Performance

As we discussed above, we think Tomen Devices' earnings were not supported by free cash flow, which might concern some investors. For this reason, we think that Tomen Devices' statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. The silver lining is that its EPS growth over the last year has been really wonderful, even if it's not a perfect measure. 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. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. Our analysis shows 3 warning signs for Tomen Devices (2 are a bit unpleasant!) and we strongly recommend you look at these before investing.

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