Shareholders Can Be Confident That Taihei Machinery Works' (TSE:6342) Earnings Are High Quality

The subdued stock price reaction suggests that Taihei Machinery Works, Limited's (TSE:6342) strong earnings didn't offer any surprises. Investors are probably missing some underlying factors which are encouraging for the future of the company.

Check out our latest analysis for Taihei Machinery Works

Zooming In On Taihei Machinery Works' 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. 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.

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 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. 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, Taihei Machinery Works recorded an accrual ratio of -0.28. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. Indeed, in the last twelve months it reported free cash flow of JP¥1.6b, well over the JP¥1.07b it reported in profit. Taihei Machinery Works shareholders are no doubt pleased that free cash flow improved over the last twelve months.

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

Our Take On Taihei Machinery Works' Profit Performance

Happily for shareholders, Taihei Machinery Works produced plenty of free cash flow to back up its statutory profit numbers. Based on this observation, we consider it possible that Taihei Machinery Works' statutory profit actually understates its earnings potential! And on top of that, its earnings per share have grown at an extremely impressive rate 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 Taihei Machinery Works as a business, it's important to be aware of any risks it's facing. In terms of investment risks, we've identified 2 warning signs with Taihei Machinery Works, and understanding them should be part of your investment process.

Today we've zoomed in on a single data point to better understand the nature of Taihei Machinery 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. 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.