KOSE R.E.Ltd's (TSE:3246) Weak Earnings May Only Reveal A Part Of The Whole Picture

The subdued market reaction suggests that KOSE R.E. Co.,Ltd.'s (TSE:3246) recent earnings didn't contain any surprises. We think that investors are worried about some weaknesses underlying the earnings.

View our latest analysis for KOSE R.E.Ltd

A Closer Look At KOSE R.E.Ltd'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. 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.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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".

KOSE R.E.Ltd has an accrual ratio of 0.55 for the year to July 2024. Statistically speaking, that's a real negative for future earnings. To wit, the company did not generate one whit of free cashflow in that time. Even though it reported a profit of JP¥371.0m, a look at free cash flow indicates it actually burnt through JP¥4.1b in the last year. We saw that FCF was JP¥6.3b a year ago though, so KOSE R.E.Ltd has at least been able to generate positive FCF in the past. One positive for KOSE R.E.Ltd 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 KOSE R.E.Ltd.

Our Take On KOSE R.E.Ltd's Profit Performance

As we have made quite clear, we're a bit worried that KOSE R.E.Ltd didn't back up the last year's profit with free cashflow. For this reason, we think that KOSE R.E.Ltd's statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. In further bad news, its earnings per share decreased in the last year. 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. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. For instance, we've identified 4 warning signs for KOSE R.E.Ltd (2 are potentially serious) you should be familiar with.

This note has only looked at a single factor that sheds light on the nature of KOSE R.E.Ltd'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. 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.