OOTOYA Holdings' (TSE:2705) Solid Profits Have Weak Fundamentals

OOTOYA Holdings Co., Ltd.'s (TSE:2705) robust earnings report didn't manage to move the market for its stock. We did some digging, and we found some concerning factors in the details.

See our latest analysis for OOTOYA Holdings

Examining Cashflow Against OOTOYA Holdings' Earnings

As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. To get the accrual ratio we first subtract FCF from profit for a period, and then divide that number by the average operating assets for the period. The ratio shows us how much a company's profit exceeds its FCF.

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 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. 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 September 2024, OOTOYA Holdings had an accrual ratio of 0.38. Ergo, its free cash flow is significantly weaker than its profit. Statistically speaking, that's a real negative for future earnings. To wit, it produced free cash flow of JP¥730m during the period, falling well short of its reported profit of JP¥1.53b. Notably OOTOYA Holdings' free cash flow was stable over the last year.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of OOTOYA Holdings.

Our Take On OOTOYA Holdings' Profit Performance

As we have made quite clear, we're a bit worried that OOTOYA Holdings didn't back up the last year's profit with free cashflow. For this reason, we think that OOTOYA Holdings' statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. But the good news is that its EPS growth over the last three years has been very impressive. Of course, we've only just scratched the surface when it comes to analysing its earnings; one could also consider margins, forecast growth, and return on investment, among other factors. So while earnings quality is important, it's equally important to consider the risks facing OOTOYA Holdings at this point in time. For example - OOTOYA Holdings has 1 warning sign we think you should be aware of.

Today we've zoomed in on a single data point to better understand the nature of OOTOYA Holdings' 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.