There May Be Underlying Issues With The Quality Of Keyware Solutions' (TSE:3799) Earnings

Keyware Solutions Inc. (TSE:3799) announced strong profits, but the stock was stagnant. Our analysis suggests that shareholders have noticed something concerning in the numbers.

We've discovered 3 warning signs about Keyware Solutions. View them for free.

A Closer Look At Keyware Solutions' 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. 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 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Keyware Solutions has an accrual ratio of 0.28 for the year to March 2025. We can therefore deduce that its free cash flow fell well short of covering its statutory profit. Even though it reported a profit of JP¥1.03b, a look at free cash flow indicates it actually burnt through JP¥679m in the last year. It's worth noting that Keyware Solutions generated positive FCF of JP¥1.1b a year ago, so at least they've done it in the past. 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. One positive for Keyware Solutions shareholders is that it's accrual ratio was significantly better last year, providing reason to believe that it may return to stronger cash conversion in the future. Shareholders should look for improved cashflow relative to profit in the current year, if that is indeed the case.

See our latest analysis for Keyware Solutions

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

The Impact Of Unusual Items On Profit

The fact that the company had unusual items boosting profit by JP¥102m, in the last year, probably goes some way to explain why its accrual ratio was so weak. 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. Which is hardly surprising, given the name. If Keyware Solutions doesn't see that contribution repeat, then all else being equal we'd expect its profit to drop over the current year.

Our Take On Keyware Solutions' Profit Performance

Keyware Solutions had a weak accrual ratio, but its profit did receive a boost from unusual items. For the reasons mentioned above, we think that a perfunctory glance at Keyware Solutions' statutory profits might make it look better than it really is on an underlying level. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. Be aware that Keyware Solutions is showing 3 warning signs in our investment analysis and 1 of those is significant...

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.