Okamoto Machine Tool Works' (TSE:6125) Promising Earnings May Rest On Soft Foundations

Despite announcing strong earnings, Okamoto Machine Tool Works, Ltd.'s (TSE:6125) stock was sluggish. We did some digging and found some worrying underlying problems.

Check out our latest analysis for Okamoto Machine Tool Works

Zooming In On Okamoto Machine Tool Works' Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. 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.

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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Over the twelve months to March 2024, Okamoto Machine Tool Works recorded an accrual ratio of 0.30. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, raising questions about how useful that profit figure really is. Over the last year it actually had negative free cash flow of JP¥2.1b, in contrast to the aforementioned profit of JP¥4.56b. We also note that Okamoto Machine Tool Works' free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of JP¥2.1b. Having said that, there is more to the story. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Okamoto Machine Tool Works.

How Do Unusual Items Influence Profit?

The fact that the company had unusual items boosting profit by JP¥431m, 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 that's as you'd expect, given these boosts are described as 'unusual'. Assuming those unusual items don't show up again in the current year, we'd thus expect profit to be weaker next year (in the absence of business growth, that is).

Our Take On Okamoto Machine Tool Works' Profit Performance

Summing up, Okamoto Machine Tool Works received a nice boost to profit from unusual items, but could not match its paper profit with free cash flow. For the reasons mentioned above, we think that a perfunctory glance at Okamoto Machine Tool Works' statutory profits might make it look better than it really is on an underlying level. If you want to do dive deeper into Okamoto Machine Tool Works, you'd also look into what risks it is currently facing. Case in point: We've spotted 2 warning signs for Okamoto Machine Tool Works you should be mindful of and 1 of them is potentially serious.

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 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. 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.