We Think That There Are Issues Underlying Brains Technology's (TSE:4075) Earnings

Brains Technology, Inc. (TSE:4075) announced strong profits, but the stock was stagnant. Our analysis suggests that shareholders have noticed something concerning in the numbers.

View our latest analysis for Brains Technology

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

Brains Technology has an accrual ratio of 0.39 for the year to January 2024. That means it didn't generate anywhere near enough free cash flow to match its profit. As a general rule, that bodes poorly for future profitability. To wit, it produced free cash flow of JP¥71m during the period, falling well short of its reported profit of JP¥166.0m. Given that Brains Technology had negative free cash flow in the prior corresponding period, the trailing twelve month resul of JP¥71m would seem to be a step in the right direction.

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

Our Take On Brains Technology's Profit Performance

As we have made quite clear, we're a bit worried that Brains Technology didn't back up the last year's profit with free cashflow. For this reason, we think that Brains Technology's statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. But the happy news is that, while acknowledging we have to look beyond the statutory numbers, those numbers are still improving, with EPS growing at a very high rate over the last year. At the end of the day, it's essential to consider more than just the factors above, if you want to understand the company properly. If you want to do dive deeper into Brains Technology, 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 Brains Technology.

Today we've zoomed in on a single data point to better understand the nature of Brains Technology's profit. 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. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying.

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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.