There May Be Reason For Hope In PRAP Japan's (TSE:2449) Disappointing Earnings

Shareholders appeared unconcerned with PRAP Japan, Inc.'s (TSE:2449) lackluster earnings report last week. We think that the softer headline numbers might be getting counterbalanced by some positive underlying factors.

We've discovered 2 warning signs about PRAP Japan. View them for free.

A Closer Look At PRAP Japan'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. The accrual ratio subtracts the FCF from the profit for a given period, and divides the result by the average operating assets of the company over that time. 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".

For the year to February 2025, PRAP Japan had an accrual ratio of -0.21. That indicates that its free cash flow quite significantly exceeded its statutory profit. To wit, it produced free cash flow of JP¥524m during the period, dwarfing its reported profit of JP¥275.0m. PRAP Japan shareholders are no doubt pleased that free cash flow improved over the last twelve months. 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.

View our latest analysis for PRAP Japan

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

The Impact Of Unusual Items On Profit

PRAP Japan's profit was reduced by unusual items worth JP¥133m in the last twelve months, and this helped it produce high cash conversion, as reflected by its unusual items. In a scenario where those unusual items included non-cash charges, we'd expect to see a strong accrual ratio, which is exactly what has happened in this case. It's never great to see unusual items costing the company profits, but on the upside, things might improve sooner rather than later. We looked at thousands of listed companies and found that unusual items are very often one-off in nature. And that's hardly a surprise given these line items are considered unusual. If PRAP Japan doesn't see those unusual expenses repeat, then all else being equal we'd expect its profit to increase over the coming year.

Our Take On PRAP Japan's Profit Performance

In conclusion, both PRAP Japan's accrual ratio and its unusual items suggest that its statutory earnings are probably reasonably conservative. Based on these factors, we think PRAP Japan's underlying earnings potential is as good as, or probably even better, than the statutory profit makes it seem! So while earnings quality is important, it's equally important to consider the risks facing PRAP Japan at this point in time. While conducting our analysis, we found that PRAP Japan has 2 warning signs and it would be unwise to ignore these.

Our examination of PRAP Japan has focussed on certain factors that can make its earnings look better than they are. And it has passed with flying colours. But there is always more to discover if you are capable of focussing your mind on minutiae. 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.