Shareholders Can Be Confident That TOKYO BASELtd's (TSE:3415) Earnings Are High Quality

TOKYO BASE Co.,Ltd.'s (TSE:3415) earnings announcement last week was disappointing for investors, despite the decent profit numbers. We have done some analysis and have found some comforting factors beneath the profit numbers.

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Examining Cashflow Against TOKYO BASELtd'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). 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.

That means a negative accrual ratio is a good thing, because it shows that the company is bringing in more free cash flow than its profit would suggest. 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

TOKYO BASELtd has an accrual ratio of -0.10 for the year to January 2025. That indicates that its free cash flow was a fair bit more than its statutory profit. To wit, it produced free cash flow of JP¥1.3b during the period, dwarfing its reported profit of JP¥776.9m. TOKYO BASELtd's free cash flow improved over the last year, which is generally good to see. However, that's not all there is to consider. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part.

See our latest analysis for TOKYO BASELtd

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.

The Impact Of Unusual Items On Profit

TOKYO BASELtd's profit was reduced by unusual items worth JP¥232m 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. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And that's hardly a surprise given these line items are considered unusual. If TOKYO BASELtd 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 TOKYO BASELtd's Profit Performance

In conclusion, both TOKYO BASELtd's accrual ratio and its unusual items suggest that its statutory earnings are probably reasonably conservative. Looking at all these factors, we'd say that TOKYO BASELtd's underlying earnings power is at least as good as the statutory numbers would make it seem. 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. Case in point: We've spotted 2 warning signs for TOKYO BASELtd you should be aware of.

Our examination of TOKYO BASELtd 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. Some people consider a high return on equity to be a good sign of a quality business. 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.