Even though Saizeriya Co.,Ltd. (TSE:7581 ) posted strong earnings, investors appeared to be underwhelmed. Our analysis says that investors should be optimistic, as the strong profit is built on solid foundations.
View our latest analysis for SaizeriyaLtd
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. 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.
For the year to August 2024, SaizeriyaLtd had an accrual ratio of -0.16. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. In fact, it had free cash flow of JP¥15b in the last year, which was a lot more than its statutory profit of JP¥8.15b. SaizeriyaLtd's year-on-year free cash flow was as flat as two-day-old fizzy drink. However, that's not all there is to consider. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part.
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.
SaizeriyaLtd's profit was reduced by unusual items worth JP¥1.6b in the last twelve months, and this helped it produce high cash conversion, as reflected by its unusual items. This is what you'd expect to see where a company has a non-cash charge reducing paper profits. While deductions due to unusual items are disappointing in the first instance, there is a silver lining. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And that's hardly a surprise given these line items are considered unusual. If SaizeriyaLtd doesn't see those unusual expenses repeat, then all else being equal we'd expect its profit to increase over the coming year.
Considering both SaizeriyaLtd's accrual ratio and its unusual items, we think its statutory earnings are unlikely to exaggerate the company's underlying earnings power. Looking at all these factors, we'd say that SaizeriyaLtd's underlying earnings power is at least as good as the statutory numbers would make it seem. Ultimately, this article has formed an opinion based on historical data. However, it can also be great to think about what analysts are forecasting for the future. So feel free to check out our free graph representing analyst forecasts.
Our examination of SaizeriyaLtd has focussed on certain factors that can make its earnings look better than they are. And it has passed with flying colours. 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.