Chugai Ro's (TSE:1964) Attractive Earnings Are Not All Good News For Shareholders

We didn't see Chugai Ro Co., Ltd.'s (TSE:1964) stock surge when it reported robust earnings recently. We decided to have a deeper look, and we believe that investors might be worried about several concerning factors that we found.

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

Examining Cashflow Against Chugai Ro'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'.

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. 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 March 2025, Chugai Ro recorded an accrual ratio of 0.27. Unfortunately, that means its free cash flow fell significantly short of its reported profits. Even though it reported a profit of JP¥3.00b, a look at free cash flow indicates it actually burnt through JP¥4.5b in the last year. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of JP¥4.5b, this year, indicates high risk. However, that's not all there is to consider. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part.

See our latest analysis for Chugai Ro

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Chugai Ro.

How Do Unusual Items Influence Profit?

Given the accrual ratio, it's not overly surprising that Chugai Ro's profit was boosted by unusual items worth JP¥1.2b in the last twelve months. 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 crunched the numbers on thousands of publicly listed companies, we found that a boost from unusual items in a given year is often not repeated the next year. And that's as you'd expect, given these boosts are described as 'unusual'. We can see that Chugai Ro's positive unusual items were quite significant relative to its profit in the year to March 2025. As a result, we can surmise that the unusual items are making its statutory profit significantly stronger than it would otherwise be.

Our Take On Chugai Ro's Profit Performance

Summing up, Chugai Ro received a nice boost to profit from unusual items, but could not match its paper profit with free cash flow. Considering all this we'd argue Chugai Ro's profits probably give an overly generous impression of its sustainable level of profitability. So while earnings quality is important, it's equally important to consider the risks facing Chugai Ro at this point in time. Our analysis shows 2 warning signs for Chugai Ro (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.