Despite DYNAM JAPAN HOLDINGS Co., Ltd.'s (HKG:6889) recent earnings report having lackluster headline numbers, the market responded positively. While shareholders may be willing to overlook soft profit numbers, we believe that they should also be taking into account some other factors which may be cause for concern.

Check out our latest analysis for DYNAM JAPAN HOLDINGS

Zooming In On DYNAM JAPAN HOLDINGS' 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'.

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.

DYNAM JAPAN HOLDINGS has an accrual ratio of 0.22 for the year to September 2023. 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 JP¥31b, in contrast to the aforementioned profit of JP¥2.49b. We saw that FCF was JP¥5.2b a year ago though, so DYNAM JAPAN HOLDINGS has at least been able to generate positive FCF in the past. One positive for DYNAM JAPAN HOLDINGS shareholders is that it's accrual ratio was significantly better last year, providing reason to believe that it may return to stronger cash conversion in the future. Shareholders should look for improved cashflow relative to profit in the current year, if that is indeed the case.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of DYNAM JAPAN HOLDINGS.

Our Take On DYNAM JAPAN HOLDINGS' Profit Performance

DYNAM JAPAN HOLDINGS didn't convert much of its profit to free cash flow in the last year, which some investors may consider rather suboptimal. Therefore, it seems possible to us that DYNAM JAPAN HOLDINGS' true underlying earnings power is actually less than its statutory profit. In further bad news, its earnings per share decreased in the last year. 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 DYNAM JAPAN HOLDINGS at this point in time. While conducting our analysis, we found that DYNAM JAPAN HOLDINGS has 3 warning signs and it would be unwise to ignore them.

Today we've zoomed in on a single data point to better understand the nature of DYNAM JAPAN HOLDINGS' 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. 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.