Earnings Troubles May Signal Larger Issues for Sata Construction (TSE:1826) Shareholders

Investors were disappointed by Sata Construction Co., Ltd.'s (TSE:1826 ) latest earnings release. Our analysis has found some reasons to be concerned, beyond the weak headline numbers.

Check out our latest analysis for Sata Construction

Zooming In On Sata Construction's Earnings

As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. 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 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

For the year to September 2024, Sata Construction had an accrual ratio of 0.75. Statistically speaking, that's a real negative for future earnings. To wit, the company did not generate one whit of free cashflow in that time. In the last twelve months it actually had negative free cash flow, with an outflow of JP¥1.7b despite its profit of JP¥358.0m, mentioned above. It's worth noting that Sata Construction generated positive FCF of JP¥1.4b a year ago, so at least they've done it in the past. The good news for shareholders is that Sata Construction's accrual ratio was much better last year, so this year's poor reading might simply be a case of a short term mismatch between profit and FCF. 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 Sata Construction.

Our Take On Sata Construction's Profit Performance

As we discussed above, we think Sata Construction's earnings were not supported by free cash flow, which might concern some investors. As a result, we think it may well be the case that Sata Construction's underlying earnings power is lower than its statutory profit. In further bad news, its earnings per share decreased in 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. In light of this, if you'd like to do more analysis on the company, it's vital to be informed of the risks involved. For instance, we've identified 5 warning signs for Sata Construction (3 are significant) you should be familiar with.

This note has only looked at a single factor that sheds light on the nature of Sata Construction'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.