Additional Considerations Required While Assessing Kimura Chemical Plants' (TSE:6378) Strong Earnings

Kimura Chemical Plants Co., Ltd.'s (TSE:6378) stock was strong after they recently reported robust earnings. We did some analysis and think that investors are missing some details hidden beneath the profit numbers.

View our latest analysis for Kimura Chemical Plants

A Closer Look At Kimura Chemical Plants' 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). 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. 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.

Over the twelve months to September 2024, Kimura Chemical Plants recorded an accrual ratio of 0.25. Unfortunately, that means its free cash flow fell significantly short of its reported profits. In the last twelve months it actually had negative free cash flow, with an outflow of JP¥634m despite its profit of JP¥2.00b, mentioned above. We saw that FCF was JP¥3.3b a year ago though, so Kimura Chemical Plants has at least been able to generate positive FCF in the past. The good news for shareholders is that Kimura Chemical Plants' accrual ratio was much better last year, so this year's poor reading might simply be a case of a short term mismatch between profit and FCF. Shareholders should look for improved cashflow relative to profit in the current year, if that is indeed the case.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Kimura Chemical Plants.

Our Take On Kimura Chemical Plants' Profit Performance

Kimura Chemical Plants didn't convert much of its profit to free cash flow in the last year, which some investors may consider rather suboptimal. Because of this, we think that it may be that Kimura Chemical Plants' statutory profits are better than its underlying earnings power. The good news is that, its earnings per share increased by 67% in the last year. The goal of this article has been to assess how well we can rely on the statutory earnings to reflect the company's potential, but there is plenty more to consider. If you'd like to know more about Kimura Chemical Plants as a business, it's important to be aware of any risks it's facing. To that end, you should learn about the 2 warning signs we've spotted with Kimura Chemical Plants (including 1 which is significant).

This note has only looked at a single factor that sheds light on the nature of Kimura Chemical Plants' 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. 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.