Koatsu KogyoLtd's (TSE:1743) Earnings Seem To Be Promising

Koatsu Kogyo Co.,Ltd.'s (TSE:1743) solid earnings announcement recently didn't do much to the stock price. We did some analysis to find out why and believe that investors might be missing some encouraging factors contained in the earnings.

We've discovered 3 warning signs about Koatsu KogyoLtd. View them for free.

Zooming In On Koatsu KogyoLtd's Earnings

In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Koatsu KogyoLtd has an accrual ratio of -0.18 for the year to March 2025. Therefore, its statutory earnings were very significantly less than its free cashflow. Indeed, in the last twelve months it reported free cash flow of JP¥2.4b, well over the JP¥656.0m it reported in profit. Given that Koatsu KogyoLtd had negative free cash flow in the prior corresponding period, the trailing twelve month resul of JP¥2.4b would seem to be a step in the right direction.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Koatsu KogyoLtd.

Our Take On Koatsu KogyoLtd's Profit Performance

As we discussed above, Koatsu KogyoLtd'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 Koatsu KogyoLtd'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 three years. 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. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. Every company has risks, and we've spotted 3 warning signs for Koatsu KogyoLtd (of which 1 is a bit concerning!) you should know about.

This note has only looked at a single factor that sheds light on the nature of Koatsu KogyoLtd's profit. But there are plenty of other ways to inform your opinion of a company. 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 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.