Shaky Earnings May Not Tell The Whole Story For Kurogane Kosakusho (TSE:7997)

The recent earnings release from Kurogane Kosakusho Ltd. (TSE:7997 ) was disappointing to investors. We looked deeper and believe that there is even more to be worried about, beyond the soft profit numbers.

View our latest analysis for Kurogane Kosakusho

Zooming In On Kurogane Kosakusho's 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). In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. This ratio tells us how much of a company's profit is not backed by free cashflow.

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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

For the year to November 2024, Kurogane Kosakusho had an accrual ratio of 0.22. We can therefore deduce that its free cash flow fell well short of covering its statutory profit. Over the last year it actually had negative free cash flow of JP¥709m, in contrast to the aforementioned profit of JP¥209.0m. We also note that Kurogane Kosakusho's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of JP¥709m. However, that's not all there is to consider. 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 Kurogane Kosakusho.

How Do Unusual Items Influence Profit?

The fact that the company had unusual items boosting profit by JP¥220m, in the last year, probably goes some way to explain why its accrual ratio was so weak. We can't deny that higher profits generally leave us optimistic, but we'd prefer it if the profit were to be sustainable. When we crunched the numbers on thousands of publicly listed companies, we found that a boost from unusual items in a given year is often not repeated the next year. Which is hardly surprising, given the name. Kurogane Kosakusho had a rather significant contribution from unusual items relative to its profit to November 2024. As a result, we can surmise that the unusual items are making its statutory profit significantly stronger than it would otherwise be.

Our Take On Kurogane Kosakusho's Profit Performance

Summing up, Kurogane Kosakusho received a nice boost to profit from unusual items, but could not match its paper profit with free cash flow. For the reasons mentioned above, we think that a perfunctory glance at Kurogane Kosakusho's statutory profits might make it look better than it really is on an underlying level. If you'd like to know more about Kurogane Kosakusho as a business, it's important to be aware of any risks it's facing. Every company has risks, and we've spotted 4 warning signs for Kurogane Kosakusho (of which 3 are concerning!) you should know about.

Our examination of Kurogane Kosakusho 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. 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. 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.