Weak Statutory Earnings May Not Tell The Whole Story For Naikai Zosen (TSE:7018)

Investors were disappointed by Naikai Zosen Corporation's (TSE:7018 ) latest earnings release. We did some further digging and think they have a few more reasons to be concerned beyond the statutory profit.

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Examining Cashflow Against Naikai Zosen's Earnings

Many investors haven't heard of the accrual ratio from cashflow, but it is actually a useful measure of how well a company's profit is backed up by free cash flow (FCF) during a given period. 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. 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Naikai Zosen has an accrual ratio of 0.97 for the year to March 2025. As a general rule, that bodes poorly for future profitability. And indeed, during the period the company didn't produce any free cash flow whatsoever. In the last twelve months it actually had negative free cash flow, with an outflow of JP¥6.6b despite its profit of JP¥1.02b, mentioned above. We saw that FCF was JP¥6.0b a year ago though, so Naikai Zosen has at least been able to generate positive FCF in the past. One positive for Naikai Zosen 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. 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 Naikai Zosen.

Our Take On Naikai Zosen's Profit Performance

As we discussed above, we think Naikai Zosen's earnings were not supported by free cash flow, which might concern some investors. As a result, we think it may well be the case that Naikai Zosen's underlying earnings power is lower than its statutory profit. But on the bright side, 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. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. Case in point: We've spotted 4 warning signs for Naikai Zosen you should be mindful of and 2 of them don't sit too well with us.

Today we've zoomed in on a single data point to better understand the nature of Naikai Zosen's profit. But there are plenty of other ways to inform your opinion of a company. For example, many people consider a high return on equity as an indication of favorable business economics, while others like to 'follow the money' and search out stocks that insiders are buying. 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.