Allied Telesis Holdings K.K's (TSE:6835) Conservative Accounting Might Explain Soft Earnings

The market was pleased with the recent earnings report from Allied Telesis Holdings K.K. (TSE:6835), despite the profit numbers being soft. We think that investors might be looking at some positive factors beyond the earnings numbers.

See our latest analysis for Allied Telesis Holdings K.K

Examining Cashflow Against Allied Telesis Holdings K.K's Earnings

As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. 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. The ratio shows us how much a company's profit exceeds its FCF.

That means a negative accrual ratio is a good thing, because it shows that the company is bringing in more free cash flow than its profit would suggest. 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Over the twelve months to June 2024, Allied Telesis Holdings K.K recorded an accrual ratio of -0.19. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. To wit, it produced free cash flow of JP¥3.1b during the period, dwarfing its reported profit of JP¥943.0m. Notably, Allied Telesis Holdings K.K had negative free cash flow last year, so the JP¥3.1b 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 Allied Telesis Holdings K.K.

Our Take On Allied Telesis Holdings K.K's Profit Performance

As we discussed above, Allied Telesis Holdings K.K's accrual ratio indicates strong conversion of profit to free cash flow, which is a positive for the company. Because of this, we think Allied Telesis Holdings K.K's underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! Unfortunately, though, its earnings per share actually fell back over the last year. 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. So while earnings quality is important, it's equally important to consider the risks facing Allied Telesis Holdings K.K at this point in time. Case in point: We've spotted 3 warning signs for Allied Telesis Holdings K.K you should be mindful of and 1 of these is a bit unpleasant.

This note has only looked at a single factor that sheds light on the nature of Allied Telesis Holdings K.K's profit. But there are plenty of other ways to inform your opinion of a company. 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 with significant insider holdings to be useful.

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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.