Why Mitsubishi Kakoki Kaisha's (TSE:6331) Earnings Are Weaker Than They Seem

After announcing healthy earnings, Mitsubishi Kakoki Kaisha, Ltd.'s (TSE:6331) stock rose over the last week. However, we think that shareholders should be aware of some other factors beyond the profit numbers.

Check out our latest analysis for Mitsubishi Kakoki Kaisha

A Closer Look At Mitsubishi Kakoki Kaisha's Earnings

As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. 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.

Therefore, it's actually considered a good thing when a company has a negative accrual ratio, but a bad thing if its accrual ratio is positive. While it's not a problem to have a positive accrual ratio, indicating a certain level of non-cash profits, a high accrual ratio is arguably a bad thing, because it indicates paper profits are not matched by cash flow. 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 March 2024, Mitsubishi Kakoki Kaisha had an accrual ratio of 0.29. Unfortunately, that means its free cash flow was a lot less than its statutory profit, which makes us doubt the utility of profit as a guide. In the last twelve months it actually had negative free cash flow, with an outflow of JP¥817m despite its profit of JP¥5.40b, mentioned above. We saw that FCF was JP¥82m a year ago though, so Mitsubishi Kakoki Kaisha has at least been able to generate positive FCF in the past. However, that's not all there is to consider. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Mitsubishi Kakoki Kaisha.

The Impact Of Unusual Items On Profit

The fact that the company had unusual items boosting profit by JP¥2.9b, in the last year, probably goes some way to explain why its accrual ratio was so weak. While we like to see profit increases, we tend to be a little more cautious when unusual items have made a big contribution. We ran the numbers on most publicly listed companies worldwide, and it's very common for unusual items to be once-off in nature. And that's as you'd expect, given these boosts are described as 'unusual'. Mitsubishi Kakoki Kaisha had a rather significant contribution from unusual items relative to its profit to March 2024. All else being equal, this would likely have the effect of making the statutory profit a poor guide to underlying earnings power.

Our Take On Mitsubishi Kakoki Kaisha's Profit Performance

Mitsubishi Kakoki Kaisha had a weak accrual ratio, but its profit did receive a boost from unusual items. Considering all this we'd argue Mitsubishi Kakoki Kaisha's profits probably give an overly generous impression of its sustainable level of profitability. If you want to do dive deeper into Mitsubishi Kakoki Kaisha, you'd also look into what risks it is currently facing. For example, we've found that Mitsubishi Kakoki Kaisha has 3 warning signs (1 is a bit concerning!) that deserve your attention before going any further with your analysis.

Our examination of Mitsubishi Kakoki Kaisha has focussed on certain factors that can make its earnings look better than they are. And, on that basis, we are somewhat skeptical. 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.