There May Be Underlying Issues With The Quality Of Nankai Tatsumura Construction's (TSE:1850) Earnings

Nankai Tatsumura Construction Co., Ltd.'s (TSE:1850) robust earnings report didn't manage to move the market for its stock. Our analysis suggests that shareholders have noticed something concerning in the numbers.

Our free stock report includes 2 warning signs investors should be aware of before investing in Nankai Tatsumura Construction. Read for free now.

Zooming In On Nankai Tatsumura Construction'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. To get the accrual ratio we first subtract FCF from profit for a period, and then divide that number by the average operating assets for the 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".

Over the twelve months to March 2025, Nankai Tatsumura Construction recorded an accrual ratio of 0.52. As a general rule, that bodes poorly for future profitability. 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¥6.3b despite its profit of JP¥1.71b, mentioned above. It's worth noting that Nankai Tatsumura Construction generated positive FCF of JP¥1.5b a year ago, so at least they've done it in the past. The good news for shareholders is that Nankai Tatsumura 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. As a result, some shareholders may be looking for stronger cash conversion in the current year.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Nankai Tatsumura Construction.

Our Take On Nankai Tatsumura Construction's Profit Performance

As we discussed above, we think Nankai Tatsumura 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 Nankai Tatsumura Construction's underlying earnings power is lower than its statutory profit. Nonetheless, it's still worth noting that its earnings per share have grown at 31% over the last three years. The goal of this article has been to assess how well we can rely on the statutory earnings to reflect the company's potential, but there is plenty more to consider. 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. Every company has risks, and we've spotted 2 warning signs for Nankai Tatsumura Construction (of which 1 is significant!) you should know about.

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