We Think Tanaka Seimitsu Kogyo's (TSE:7218) Robust Earnings Are Conservative

Tanaka Seimitsu Kogyo Co., Ltd.'s (TSE:7218) earnings announcement last week was disappointing for investors, despite the decent profit numbers. We did some digging and actually think they are being unnecessarily pessimistic.

Check out our latest analysis for Tanaka Seimitsu Kogyo

A Closer Look At Tanaka Seimitsu Kogyo's Earnings

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. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. The ratio shows us how much a company's profit exceeds its FCF.

Therefore, it's actually considered a good thing when a company has a negative accrual ratio, but a bad thing if its accrual ratio is positive. That is not intended to imply we should worry about a positive accrual ratio, but it's worth noting where the accrual ratio is rather high. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

For the year to March 2024, Tanaka Seimitsu Kogyo had an accrual ratio of -0.11. Therefore, its statutory earnings were quite a lot less than its free cashflow. In fact, it had free cash flow of JP¥4.9b in the last year, which was a lot more than its statutory profit of JP¥2.22b. Tanaka Seimitsu Kogyo shareholders are no doubt pleased that free cash flow improved over the last twelve months.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Tanaka Seimitsu Kogyo.

Our Take On Tanaka Seimitsu Kogyo's Profit Performance

Tanaka Seimitsu Kogyo's accrual ratio is solid, and indicates strong free cash flow, as we discussed, above. Based on this observation, we consider it likely that Tanaka Seimitsu Kogyo's statutory profit actually understates its earnings potential! And on top of that, its earnings per share have grown at an extremely impressive rate over the last year. At the end of the day, it's essential to consider more than just the factors above, if you want to understand the company properly. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. Case in point: We've spotted 2 warning signs for Tanaka Seimitsu Kogyo you should be aware of.

This note has only looked at a single factor that sheds light on the nature of Tanaka Seimitsu Kogyo'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. 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 with significant insider holdings 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.