Sanken Electric (TSE:6707) Is Posting Solid Earnings, But It Is Not All Good News

Solid profit numbers didn't seem to be enough to please Sanken Electric Co., Ltd.'s (TSE:6707) shareholders. We think that they might be concerned about some underlying details that our analysis found.

See our latest analysis for Sanken Electric

Examining Cashflow Against Sanken Electric'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. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. This ratio tells us how much of a company's profit is not backed by free cashflow.

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.

Sanken Electric has an accrual ratio of 0.39 for the year to September 2024. Statistically speaking, that's a real negative for future earnings. To wit, the company did not generate one whit of free cashflow in that time. Over the last year it actually had negative free cash flow of JP¥30b, in contrast to the aforementioned profit of JP¥35.4b. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of JP¥30b, this year, indicates high risk. 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.

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.

How Do Unusual Items Influence Profit?

Given the accrual ratio, it's not overly surprising that Sanken Electric's profit was boosted by unusual items worth JP¥57b in the last twelve months. While it's always nice to have higher profit, a large contribution from unusual items sometimes dampens our enthusiasm. We ran the numbers on most publicly listed companies worldwide, and it's very common for unusual items to be once-off in nature. And, after all, that's exactly what the accounting terminology implies. We can see that Sanken Electric's positive unusual items were quite significant relative to its profit in the year to September 2024. As a result, we can surmise that the unusual items are making its statutory profit significantly stronger than it would otherwise be.

Our Take On Sanken Electric's Profit Performance

Summing up, Sanken Electric 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 Sanken Electric's profits probably give an overly generous impression of its sustainable level of profitability. If you want to do dive deeper into Sanken Electric, you'd also look into what risks it is currently facing. To help with this, we've discovered 3 warning signs (2 are a bit concerning!) that you ought to be aware of before buying any shares in Sanken Electric.

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. 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.

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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.