Nakakita Seisakusho (TSE:6496) Is Posting Healthy Earnings, But It Is Not All Good News

Strong earnings weren't enough to please Nakakita Seisakusho Co., Ltd.'s (TSE:6496) shareholders over the last week. Our analysis found several concerning factors in the earnings report beyond the strong statutory profit number.

Check out our latest analysis for Nakakita Seisakusho

Zooming In On Nakakita Seisakusho's Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. The ratio shows us how much a company's profit exceeds its FCF.

That means a negative accrual ratio is a good thing, because it shows that the company is bringing in more free cash flow than its profit would suggest. 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

For the year to November 2024, Nakakita Seisakusho had an accrual ratio of 0.23. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, which is hardly a good thing. Over the last year it actually had negative free cash flow of JP¥3.1b, in contrast to the aforementioned profit of JP¥1.46b. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of JP¥3.1b, this year, indicates high risk. Having said that, there is more to the story. 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 Nakakita Seisakusho.

The Impact Of Unusual Items On Profit

The fact that the company had unusual items boosting profit by JP¥972m, in the last year, probably goes some way to explain why its accrual ratio was so weak. While it's always nice to have higher profit, a large contribution from unusual items sometimes dampens our enthusiasm. 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 Nakakita Seisakusho's positive unusual items were quite significant relative to its profit in the year to November 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 Nakakita Seisakusho's Profit Performance

Summing up, Nakakita Seisakusho received a nice boost to profit from unusual items, but could not match its paper profit with free cash flow. Considering all this we'd argue Nakakita Seisakusho's profits probably give an overly generous impression of its sustainable level of profitability. So while earnings quality is important, it's equally important to consider the risks facing Nakakita Seisakusho at this point in time. For example, we've found that Nakakita Seisakusho has 2 warning signs (1 is significant!) that deserve your attention before going any further with your analysis.

Our examination of Nakakita Seisakusho 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.

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.