Komehyo HoldingsLtd's (TSE:2780) Shareholders May Want To Dig Deeper Than Statutory Profit

Komehyo Holdings Co.,Ltd. (TSE:2780) just released a solid earnings report, and the stock displayed some strength. Despite this, our analysis suggests that there are some factors weakening the foundations of those good profit numbers.

See our latest analysis for Komehyo HoldingsLtd

Examining Cashflow Against Komehyo HoldingsLtd's 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. 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 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".

Komehyo HoldingsLtd has an accrual ratio of 0.25 for the year to March 2024. Unfortunately, that means its free cash flow fell significantly short of its reported profits. Even though it reported a profit of JP¥5.03b, a look at free cash flow indicates it actually burnt through JP¥3.3b in the last year. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of JP¥3.3b, this year, indicates high risk.

That might leave you wondering what analysts are forecasting in terms of future profitability. Luckily, you can click here to see an interactive graph depicting future profitability, based on their estimates.

Our Take On Komehyo HoldingsLtd's Profit Performance

Komehyo HoldingsLtd's accrual ratio for the last twelve months signifies cash conversion is less than ideal, which is a negative when it comes to our view of its earnings. Therefore, it seems possible to us that Komehyo HoldingsLtd's true underlying earnings power is actually less than its statutory profit. The good news is that, its earnings per share increased by 36% in 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. So while earnings quality is important, it's equally important to consider the risks facing Komehyo HoldingsLtd at this point in time. To that end, you should learn about the 3 warning signs we've spotted with Komehyo HoldingsLtd (including 1 which shouldn't be ignored).

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

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.