Kanda Tsushinki's (TYO:1992) Earnings Are Growing But Is There More To The Story?

Statistically speaking, it is less risky to invest in profitable companies than in unprofitable ones. However, sometimes companies receive a one-off boost (or reduction) to their profit, and it's not always clear whether statutory profits are a good guide, going forward. This article will consider whether Kanda Tsushinki's (TYO:1992) statutory profits are a good guide to its underlying earnings.

We like the fact that Kanda Tsushinki made a profit of JP¥343.0m on its revenue of JP¥6.10b, in the last year. One positive is that it has grown both its profit and its revenue, over the last few years.

Check out our latest analysis for Kanda Tsushinki

Of course, it is only sensible to look beyond the statutory profits and question how well those numbers represent the sustainable earnings power of the business. Today, we'll discuss Kanda Tsushinki's free cashflow relative to its earnings, and consider what that tells us about the company. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Kanda Tsushinki.

A Closer Look At Kanda Tsushinki's Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. 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.

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. 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.

Over the twelve months to September 2020, Kanda Tsushinki recorded an accrual ratio of -0.18. That indicates that its free cash flow quite significantly exceeded its statutory profit. Indeed, in the last twelve months it reported free cash flow of JP¥766m, well over the JP¥343.0m it reported in profit. Notably, Kanda Tsushinki had negative free cash flow last year, so the JP¥766m it produced this year was a welcome improvement.

Our Take On Kanda Tsushinki's Profit Performance

As we discussed above, Kanda Tsushinki's accrual ratio indicates strong conversion of profit to free cash flow, which is a positive for the company. Based on this observation, we consider it possible that Kanda Tsushinki's statutory profit actually understates its earnings potential! Better yet, its EPS are growing strongly, which is nice to see. 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. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. Case in point: We've spotted 1 warning sign for Kanda Tsushinki you should be aware of.

Today we've zoomed in on a single data point to better understand the nature of Kanda Tsushinki's 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. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying.

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This article by Simply Wall St is general in nature. 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.
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