Additional Considerations Required While Assessing Wakachiku Construction's (TSE:1888) Strong Earnings

Investors were disappointed with Wakachiku Construction Co., Ltd.'s (TSE:1888) earnings, despite the strong profit numbers. Our analysis uncovered some concerning factors that we believe the market might be paying attention to.

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Examining Cashflow Against Wakachiku Construction'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). 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. This ratio tells us how much of a company's profit is not backed by free cashflow.

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.

Over the twelve months to September 2025, Wakachiku Construction recorded an accrual ratio of 0.42. 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¥12b despite its profit of JP¥4.39b, mentioned above. It's worth noting that Wakachiku Construction generated positive FCF of JP¥9.0b a year ago, so at least they've done it in the past. One positive for Wakachiku Construction shareholders is that it's accrual ratio was significantly better last year, providing reason to believe that it may return to stronger cash conversion in the future. 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 Wakachiku Construction.

Our Take On Wakachiku Construction's Profit Performance

As we have made quite clear, we're a bit worried that Wakachiku Construction didn't back up the last year's profit with free cashflow. As a result, we think it may well be the case that Wakachiku Construction's underlying earnings power is lower than its statutory profit. The good news is that, its earnings per share increased by 44% in the last year. 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. If you'd like to know more about Wakachiku Construction as a business, it's important to be aware of any risks it's facing. For example, we've found that Wakachiku Construction has 2 warning signs (1 can't be ignored!) that deserve your attention before going any further with your analysis.

Today we've zoomed in on a single data point to better understand the nature of Wakachiku Construction'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. 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.