Tokyo Energy & Systems' (TSE:1945) Weak Earnings Might Be Worse Than They Appear

Tokyo Energy & Systems Inc.'s (TSE:1945) stock wasn't much affected by its recent lackluster earnings numbers. We did some analysis and found some concerning details beneath the statutory profit number.

We've discovered 2 warning signs about Tokyo Energy & Systems. View them for free.

Examining Cashflow Against Tokyo Energy & Systems' Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. 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. 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Tokyo Energy & Systems has an accrual ratio of 0.26 for the year to March 2025. Unfortunately, that means its free cash flow fell significantly short of its reported profits. Even though it reported a profit of JP¥2.90b, a look at free cash flow indicates it actually burnt through JP¥16b in the last year. It's worth noting that Tokyo Energy & Systems generated positive FCF of JP¥7.6b a year ago, so at least they've done it in the past. Having said that, there is more to the story. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio. One positive for Tokyo Energy & Systems 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.

View our latest analysis for Tokyo Energy & Systems

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Tokyo Energy & Systems.

The Impact Of Unusual Items On Profit

The fact that the company had unusual items boosting profit by JP¥1.7b, in the last year, probably goes some way to explain why its accrual ratio was so weak. We can't deny that higher profits generally leave us optimistic, but we'd prefer it if the profit were to be sustainable. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And, after all, that's exactly what the accounting terminology implies. We can see that Tokyo Energy & Systems' positive unusual items were quite significant relative to its profit in the year to March 2025. All else being equal, this would likely have the effect of making the statutory profit a poor guide to underlying earnings power.

Our Take On Tokyo Energy & Systems' Profit Performance

Tokyo Energy & Systems had a weak accrual ratio, but its profit did receive a boost from unusual items. Considering all this we'd argue Tokyo Energy & Systems' profits probably give an overly generous impression of its sustainable level of profitability. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. Our analysis shows 2 warning signs for Tokyo Energy & Systems (1 is concerning!) and we strongly recommend you look at these before investing.

In this article we've looked at a number of factors that can impair the utility of profit numbers, and we've come away cautious. 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.