Taihei Machinery Works' (TSE:6342) Solid Profits Have Weak Fundamentals

Taihei Machinery Works, Limited (TSE:6342) announced strong profits, but the stock was stagnant. Our analysis suggests that this might be because shareholders have noticed some concerning underlying factors.

View our latest analysis for Taihei Machinery Works

Zooming In On Taihei Machinery Works' 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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Taihei Machinery Works has an accrual ratio of 0.55 for the year to September 2024. Ergo, its free cash flow is significantly weaker than its profit. Statistically speaking, that's a real negative for future earnings. In fact, it had free cash flow of JP¥151m in the last year, which was a lot less than its statutory profit of JP¥1.38b. Taihei Machinery Works shareholders will no doubt be hoping that its free cash flow bounces back next year, since it was down over the last twelve months. One positive for Taihei Machinery Works shareholders is that it's accrual ratio was significantly better last year, providing reason to believe that it may return to stronger cash conversion in the future. As a result, some shareholders may be looking for stronger cash conversion in the current year.

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

As we discussed above, we think Taihei Machinery Works' earnings were not supported by free cash flow, which might concern some investors. For this reason, we think that Taihei Machinery Works' statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. The good news is that, its earnings per share increased by 39% in the last year. Of course, we've only just scratched the surface when it comes to analysing its earnings; one could also consider margins, forecast growth, and return on investment, among other factors. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. Every company has risks, and we've spotted 3 warning signs for Taihei Machinery Works (of which 1 is potentially serious!) you should know about.

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