Last week's profit announcement from Morimatsu International Holdings Company Limited (HKG:2155) was underwhelming for investors, despite headline numbers being robust. Our analysis uncovered some concerning factors that we believe the market might be paying attention to.

A Closer Look At Morimatsu International Holdings' 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.

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. 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 December 2023, Morimatsu International Holdings had an accrual ratio of 0.36. We can therefore deduce that its free cash flow fell well short of covering its statutory profit, suggesting we might want to think twice before putting a lot of weight on the latter. In fact, it had free cash flow of CN¥100m in the last year, which was a lot less than its statutory profit of CN¥844.7m. We note, however, that Morimatsu International Holdings grew its free cash flow over the last year.

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 Morimatsu International Holdings' Profit Performance

As we discussed above, we think Morimatsu International Holdings' earnings were not supported by free cash flow, which might concern some investors. For this reason, we think that Morimatsu International Holdings' statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. But the good news is that its EPS growth over the last three years has been very impressive. 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 if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. For example, Morimatsu International Holdings has 2 warning signs (and 1 which doesn't sit too well with us) we think you should know about.

This note has only looked at a single factor that sheds light on the nature of Morimatsu International Holdings' 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. 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 that insiders are buying 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.