Prime Strategy's (TSE:5250) Weak Earnings May Only Reveal A Part Of The Whole Picture

A lackluster earnings announcement from Prime Strategy Co., Ltd. (TSE:5250) last week didn't sink the stock price. We think that investors are worried about some weaknesses underlying the earnings.

View our latest analysis for Prime Strategy

Zooming In On Prime Strategy'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. 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Over the twelve months to November 2024, Prime Strategy recorded an accrual ratio of 0.40. That means it didn't generate anywhere near enough free cash flow to match its profit. Statistically speaking, that's a real negative for future earnings. To wit, it produced free cash flow of JP¥117m during the period, falling well short of its reported profit of JP¥151.0m. Prime Strategy's free cash flow actually declined over the last year, but it may bounce back next year, since free cash flow is often more volatile than accounting profits.

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

Our Take On Prime Strategy's Profit Performance

As we discussed above, we think Prime Strategy's earnings were not supported by free cash flow, which might concern some investors. As a result, we think it may well be the case that Prime Strategy's underlying earnings power is lower than its statutory profit. But at least holders can take some solace from the 30% per annum growth in EPS for the last three. Of course, we've only just scratched the surface when it comes to analysing its earnings; one could also consider margins, forecast growth, and return on investment, among other factors. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. When we did our research, we found 3 warning signs for Prime Strategy (1 is a bit concerning!) that we believe deserve your full attention.

This note has only looked at a single factor that sheds light on the nature of Prime Strategy'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. 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.