Wakachiku Construction's (TSE:1888) Problems Go Beyond Weak Profit

A lackluster earnings announcement from Wakachiku Construction Co., Ltd. (TSE:1888) last week didn't sink the stock price. Our analysis suggests that along with soft profit numbers, investors should be aware of some other underlying weaknesses in the numbers.

Check out our latest analysis for Wakachiku Construction

Examining Cashflow Against Wakachiku 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. 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'.

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. 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 March 2024, Wakachiku Construction had an accrual ratio of 0.40. As a general rule, that bodes poorly for future profitability. And indeed, during the period the company didn't produce any free cash flow whatsoever. Over the last year it actually had negative free cash flow of JP¥5.4b, in contrast to the aforementioned profit of JP¥5.09b. It's worth noting that Wakachiku Construction generated positive FCF of JP¥14b a year ago, so at least they've done it in the past. The good news for shareholders is that Wakachiku 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 Wakachiku Construction.

Our Take On Wakachiku Construction's Profit Performance

As we discussed above, we think Wakachiku Construction's earnings were not supported by free cash flow, which might concern some investors. For this reason, we think that Wakachiku Construction's statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. But on the bright side, 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. 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. When we did our research, we found 2 warning signs for Wakachiku Construction (1 is a bit unpleasant!) that we believe deserve your full attention.

This note has only looked at a single factor that sheds light on the nature of Wakachiku Construction's profit. But there is always more to discover if you are capable of focussing your mind on minutiae. Some people consider a high return on equity to be a good sign of a quality business. 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.