CAVE InteractiveLTD's (TSE:3760) Anemic Earnings Might Be Worse Than You Think

Last week's earnings announcement from CAVE Interactive CO.,LTD. (TSE:3760) was disappointing to investors, with a sluggish profit figure. Our analysis has found some reasons to be concerned, beyond the weak headline numbers.

View our latest analysis for CAVE InteractiveLTD

Zooming In On CAVE InteractiveLTD's Earnings

In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). 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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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.

CAVE InteractiveLTD has an accrual ratio of 0.61 for the year to November 2024. As a general rule, that bodes poorly for future profitability. And indeed, during the period the company didn't produce any free cash flow whatsoever. In the last twelve months it actually had negative free cash flow, with an outflow of JP¥299m despite its profit of JP¥1.26b, mentioned above. It's worth noting that CAVE InteractiveLTD generated positive FCF of JP¥170m a year ago, so at least they've done it in the past.

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

Our Take On CAVE InteractiveLTD's Profit Performance

As we discussed above, we think CAVE InteractiveLTD'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 CAVE InteractiveLTD's underlying earnings power is lower than its statutory profit. In further bad news, its earnings per share decreased in the last year. 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. If you want to do dive deeper into CAVE InteractiveLTD, you'd also look into what risks it is currently facing. For example, we've found that CAVE InteractiveLTD has 4 warning signs (1 is significant!) that deserve your attention before going any further with your analysis.

This note has only looked at a single factor that sheds light on the nature of CAVE InteractiveLTD'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.