Some Investors May Be Willing To Look Past Taiyo Koki's (TSE:6164) Soft Earnings

Taiyo Koki Co., Ltd.'s (TSE:6164) recent soft profit numbers didn't appear to worry shareholders, as the stock price showed strength. However, we think the company is showing some signs that things are more promising than they seem.

Check out our latest analysis for Taiyo Koki

Zooming In On Taiyo Koki's Earnings

In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). 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. 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. 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".

Taiyo Koki has an accrual ratio of -0.12 for the year to December 2023. That implies it has good cash conversion, and implies that its free cash flow solidly exceeded its profit last year. To wit, it produced free cash flow of JP¥1.2b during the period, dwarfing its reported profit of JP¥415.0m. Given that Taiyo Koki had negative free cash flow in the prior corresponding period, the trailing twelve month resul of JP¥1.2b would seem to be a step in the right direction.

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

Our Take On Taiyo Koki's Profit Performance

Taiyo Koki's accrual ratio is solid, and indicates strong free cash flow, as we discussed, above. Because of this, we think Taiyo Koki's earnings potential is at least as good as it seems, and maybe even better! And on top of that, its earnings per share have grown at 22% per year over the last three years. At the end of the day, it's essential to consider more than just the factors above, if you want to understand the company properly. If you'd like to know more about Taiyo Koki as a business, it's important to be aware of any risks it's facing. To help with this, we've discovered 2 warning signs (1 is concerning!) that you ought to be aware of before buying any shares in Taiyo Koki.

Today we've zoomed in on a single data point to better understand the nature of Taiyo Koki's 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. 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 that insiders are buying 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.