We Think That There Are Issues Underlying Japan Steel Works' (TSE:5631) Earnings

Unsurprisingly, The Japan Steel Works, Ltd.'s (TSE:5631) stock price was strong on the back of its healthy earnings report. However, we think that shareholders may be missing some concerning details in the numbers.

View our latest analysis for Japan Steel Works

Examining Cashflow Against Japan Steel Works' 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. 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. The ratio shows us how much a company's profit exceeds its FCF.

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. 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.

For the year to September 2024, Japan Steel Works had an accrual ratio of 0.23. Unfortunately, that means its free cash flow fell significantly short of its reported profits. Even though it reported a profit of JP¥15.5b, a look at free cash flow indicates it actually burnt through JP¥15b in the last year. We also note that Japan Steel Works' free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of JP¥15b.

That might leave you wondering what analysts are forecasting in terms of future profitability. Luckily, you can click here to see an interactive graph depicting future profitability, based on their estimates.

Our Take On Japan Steel Works' Profit Performance

Japan Steel Works didn't convert much of its profit to free cash flow in the last year, which some investors may consider rather suboptimal. Because of this, we think that it may be that Japan Steel Works' statutory profits are better than its underlying earnings power. Nonetheless, it's still worth noting that its earnings per share have grown at 55% 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. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. Case in point: We've spotted 2 warning signs for Japan Steel Works you should be aware of.

This note has only looked at a single factor that sheds light on the nature of Japan Steel Works' profit. But there are plenty of other ways to inform your opinion of a company. 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.