Nihon Seiko's (TSE:5729) Solid Profits Have Weak Fundamentals

Despite announcing strong earnings, Nihon Seiko Co., Ltd.'s (TSE:5729) stock was sluggish. We did some digging and found some worrying underlying problems.

We've discovered 4 warning signs about Nihon Seiko. View them for free.

A Closer Look At Nihon Seiko'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. 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Nihon Seiko has an accrual ratio of 0.35 for the year to March 2025. Unfortunately, that means its free cash flow was a lot less than its statutory profit, which makes us doubt the utility of profit as a guide. Over the last year it actually had negative free cash flow of JP¥1.5b, in contrast to the aforementioned profit of JP¥2.46b. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of JP¥1.5b, this year, indicates high risk.

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

Our Take On Nihon Seiko's Profit Performance

As we discussed above, we think Nihon Seiko'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 Nihon Seiko's underlying earnings power is lower than its statutory profit. But the happy news is that, while acknowledging we have to look beyond the statutory numbers, those numbers are still improving, with EPS growing at a very high rate over the last year. The goal of this article has been to assess how well we can rely on the statutory earnings to reflect the company's potential, but there is plenty more to consider. In light of this, if you'd like to do more analysis on the company, it's vital to be informed of the risks involved. To help with this, we've discovered 4 warning signs (2 are significant!) that you ought to be aware of before buying any shares in Nihon Seiko.

This note has only looked at a single factor that sheds light on the nature of Nihon Seiko's profit. But there are plenty of other ways to inform your opinion of a company. 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.