JSL Construction & Development's (TWSE:2540) Earnings Are Of Questionable Quality

Despite posting some strong earnings, the market for JSL Construction & Development Co., Ltd.'s (TWSE:2540) stock hasn't moved much. Our analysis suggests that this might be because shareholders have noticed some concerning underlying factors.

Check out our latest analysis for JSL Construction & Development

Examining Cashflow Against JSL Construction & Development'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). 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.

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

Over the twelve months to December 2023, JSL Construction & Development recorded an accrual ratio of 0.24. We can therefore deduce that its free cash flow fell well short of covering its statutory profit. Over the last year it actually had negative free cash flow of NT$3.3b, in contrast to the aforementioned profit of NT$1.51b. We also note that JSL Construction & Development's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of NT$3.3b.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of JSL Construction & Development.

Our Take On JSL Construction & Development's Profit Performance

JSL Construction & Development's accrual ratio for the last twelve months signifies cash conversion is less than ideal, which is a negative when it comes to our view of its earnings. Because of this, we think that it may be that JSL Construction & Development's statutory profits are better than its underlying earnings power. The silver lining is that its EPS growth over the last year has been really wonderful, even if it's not a perfect measure. 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. If you'd like to know more about JSL Construction & Development as a business, it's important to be aware of any risks it's facing. Every company has risks, and we've spotted 2 warning signs for JSL Construction & Development you should know about.

Today we've zoomed in on a single data point to better understand the nature of JSL Construction & Development'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. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.