We Think That There Are More Issues For Prime Strategy (TSE:5250) Than Just Sluggish Earnings

Despite Prime Strategy Co., Ltd.'s (TSE:5250) recent earnings report having lackluster headline numbers, the market responded positively. Sometimes, shareholders are willing to ignore soft numbers with the hope that they will improve, but our analysis suggests this is unlikely for Prime Strategy.

View our latest analysis for Prime Strategy

A Closer Look At Prime Strategy'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). 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.

Therefore, it's actually considered a good thing when a company has a negative accrual ratio, but a bad thing if its accrual ratio is positive. 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Prime Strategy has an accrual ratio of 0.49 for the year to May 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. Indeed, in the last twelve months it reported free cash flow of JP¥133m, which is significantly less than its profit of JP¥158.0m. As it happens we don't have the data on what Prime Strategy produced by way of free cashflow, the year before, which is a pity.

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 on the bright side, its earnings per share have grown at an extremely impressive rate over the last three years. 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'd like to know more about Prime Strategy as a business, it's important to be aware of any risks it's facing. Our analysis shows 3 warning signs for Prime Strategy (2 are concerning!) and we strongly recommend you look at them before investing.

This note has only looked at a single factor that sheds light on the nature of Prime Strategy's profit. But there is always more to discover if you are capable of focussing your mind on minutiae. 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. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com