Kamakura Shinsho's (TSE:6184) Earnings Might Be Weaker Than You Think

Kamakura Shinsho, Ltd.'s (TSE:6184) solid earnings report last week was underwhelming to investors. We did some digging and found some worrying factors that they might be paying attention to.

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A Closer Look At Kamakura Shinsho'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. The ratio shows us how much a company's profit exceeds its FCF.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. That is not intended to imply we should worry about a positive accrual ratio, but it's worth noting where the accrual ratio is rather high. 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 January 2025, Kamakura Shinsho recorded an accrual ratio of 0.41. That means it didn't generate anywhere near enough free cash flow to match its profit. Statistically speaking, that's a real negative for future earnings. To wit, it produced free cash flow of JP¥84m during the period, falling well short of its reported profit of JP¥687.0m. At this point we should mention that Kamakura Shinsho did manage to increase its free cash flow in the last twelve months Having said that, there is more to the story. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio.

View our latest analysis for Kamakura Shinsho

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

How Do Unusual Items Influence Profit?

Given the accrual ratio, it's not overly surprising that Kamakura Shinsho's profit was boosted by unusual items worth JP¥85m in the last twelve months. We can't deny that higher profits generally leave us optimistic, but we'd prefer it if the profit were to be sustainable. When we crunched the numbers on thousands of publicly listed companies, we found that a boost from unusual items in a given year is often not repeated the next year. And that's as you'd expect, given these boosts are described as 'unusual'. Assuming those unusual items don't show up again in the current year, we'd thus expect profit to be weaker next year (in the absence of business growth, that is).

Our Take On Kamakura Shinsho's Profit Performance

Summing up, Kamakura Shinsho received a nice boost to profit from unusual items, but could not match its paper profit with free cash flow. Considering all this we'd argue Kamakura Shinsho's profits probably give an overly generous impression of its sustainable level of profitability. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. To help with this, we've discovered 2 warning signs (1 shouldn't be ignored!) that you ought to be aware of before buying any shares in Kamakura Shinsho.

In this article we've looked at a number of factors that can impair the utility of profit numbers, and we've come away cautious. 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. While it might take a little research on your behalf, you may find this free collection of companies boasting high return on equity, or this list of stocks with significant insider holdings to be useful.

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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.