ToumeiLtd's (TSE:4439) Strong Earnings Are Of Good Quality

The subdued stock price reaction suggests that Toumei Co.,Ltd.'s (TSE:4439) strong earnings didn't offer any surprises. We think that investors have missed some encouraging factors underlying the profit figures.

See our latest analysis for ToumeiLtd

A Closer Look At ToumeiLtd's Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. 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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

For the year to February 2024, ToumeiLtd had an accrual ratio of -0.76. That indicates that its free cash flow quite significantly exceeded its statutory profit. In fact, it had free cash flow of JP¥4.8b in the last year, which was a lot more than its statutory profit of JP¥1.25b. Notably, ToumeiLtd had negative free cash flow last year, so the JP¥4.8b it produced this year was a welcome improvement.

That might leave you wondering what analysts are forecasting in terms of future profitability. Luckily, you can click here to see an interactive graph depicting future profitability, based on their estimates.

Our Take On ToumeiLtd's Profit Performance

As we discussed above, ToumeiLtd's accrual ratio indicates strong conversion of profit to free cash flow, which is a positive for the company. Because of this, we think ToumeiLtd'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. Of course, we've only just scratched the surface when it comes to analysing its earnings; one could also consider margins, forecast growth, and return on investment, among other factors. So while earnings quality is important, it's equally important to consider the risks facing ToumeiLtd at this point in time. You'd be interested to know, that we found 2 warning signs for ToumeiLtd and you'll want to know about these.

This note has only looked at a single factor that sheds light on the nature of ToumeiLtd's profit. But there is always more to discover if you are capable of focussing your mind on minutiae. 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 that insiders are buying.

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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.