Weak Statutory Earnings May Not Tell The Whole Story For Kato Sangyo (TSE:9869)

The subdued market reaction suggests that Kato Sangyo Co., Ltd.'s (TSE:9869) recent earnings didn't contain any surprises. Our analysis suggests that along with soft profit numbers, investors should be aware of some other underlying weaknesses in the numbers.

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Examining Cashflow Against Kato Sangyo'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. 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. 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 2025, Kato Sangyo recorded an accrual ratio of 0.26. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, which is hardly a good thing. In the last twelve months it actually had negative free cash flow, with an outflow of JP¥11b despite its profit of JP¥13.2b, mentioned above. It's worth noting that Kato Sangyo generated positive FCF of JP¥17b a year ago, so at least they've done it in the past. One positive for Kato Sangyo 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 Kato Sangyo.

Our Take On Kato Sangyo's Profit Performance

Kato Sangyo 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 Kato Sangyo's statutory profits are better than its underlying earnings power. Nonetheless, it's still worth noting that its earnings per share have grown at 29% 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. If you want to do dive deeper into Kato Sangyo, you'd also look into what risks it is currently facing. Case in point: We've spotted 2 warning signs for Kato Sangyo you should be mindful of and 1 of them is potentially serious.

Today we've zoomed in on a single data point to better understand the nature of Kato Sangyo's 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.