Investors Can Find Comfort In Niraku GC Holdings' (HKG:1245) Earnings Quality

The market for Niraku GC Holdings, Inc.'s (HKG:1245) shares didn't move much after it posted weak earnings recently. We think that the softer headline numbers might be getting counterbalanced by some positive underlying factors.

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Zooming In On Niraku GC 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'.

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.

Niraku GC Holdings has an accrual ratio of -0.20 for the year to March 2025. That indicates that its free cash flow quite significantly exceeded its statutory profit. In fact, it had free cash flow of JP¥4.0b in the last year, which was a lot more than its statutory profit of JP¥607.0m. Niraku GC Holdings' free cash flow actually declined over the last year, which is disappointing, like non-biodegradable balloons. Having said that, there is more to the story. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part.

See our latest analysis for Niraku GC Holdings

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Niraku GC Holdings.

The Impact Of Unusual Items On Profit

Niraku GC Holdings' profit was reduced by unusual items worth JP¥448m in the last twelve months, and this helped it produce high cash conversion, as reflected by its unusual items. In a scenario where those unusual items included non-cash charges, we'd expect to see a strong accrual ratio, which is exactly what has happened in this case. It's never great to see unusual items costing the company profits, but on the upside, things might improve sooner rather than later. 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 Niraku GC Holdings doesn't see those unusual expenses repeat, then all else being equal we'd expect its profit to increase over the coming year.

Our Take On Niraku GC Holdings' Profit Performance

In conclusion, both Niraku GC Holdings' accrual ratio and its unusual items suggest that its statutory earnings are probably reasonably conservative. After considering all this, we reckon Niraku GC Holdings' statutory profit probably understates its earnings potential! If you'd like to know more about Niraku GC Holdings as a business, it's important to be aware of any risks it's facing. Case in point: We've spotted 3 warning signs for Niraku GC Holdings you should be aware of.

Our examination of Niraku GC Holdings 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.