Statutory Profit Doesn't Reflect How Good Nakamura Choukou's (TSE:6166) Earnings Are

Investors were disappointed with Nakamura Choukou Co., Ltd.'s (TSE:6166) earnings, despite the strong profit numbers. We did some digging and found some worrying underlying problems.

See our latest analysis for Nakamura Choukou

A Closer Look At Nakamura Choukou'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'.

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.

For the year to September 2024, Nakamura Choukou had an accrual ratio of -0.39. That indicates that its free cash flow quite significantly exceeded its statutory profit. In fact, it had free cash flow of JP¥1.4b in the last year, which was a lot more than its statutory profit of JP¥384.0m. Given that Nakamura Choukou had negative free cash flow in the prior corresponding period, the trailing twelve month resul of JP¥1.4b would seem to be a step in the right direction. 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.

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

How Do Unusual Items Influence Profit?

While the accrual ratio might bode well, we also note that Nakamura Choukou's profit was boosted by unusual items worth JP¥1.1b 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 analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. Which is hardly surprising, given the name. We can see that Nakamura Choukou's positive unusual items were quite significant relative to its profit in the year to September 2024. 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 Nakamura Choukou's Profit Performance

Nakamura Choukou's profits got a boost from unusual items, which indicates they might not be sustained and yet its accrual ratio still indicated solid cash conversion, which is promising. Based on these factors, it's hard to tell if Nakamura Choukou's profits are a reasonable reflection of its underlying profitability. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. To that end, you should learn about the 4 warning signs we've spotted with Nakamura Choukou (including 1 which makes us a bit uncomfortable).

In this article we've looked at a number of factors that can impair the utility of profit numbers, as a guide to a business. 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. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.