Are Kyoritsu Electric's (TYO:6874) Statutory Earnings A Good Reflection Of Its Earnings Potential?

Statistically speaking, it is less risky to invest in profitable companies than in unprofitable ones. However, sometimes companies receive a one-off boost (or reduction) to their profit, and it's not always clear whether statutory profits are a good guide, going forward. This article will consider whether Kyoritsu Electric's (TYO:6874) statutory profits are a good guide to its underlying earnings.

It's good to see that over the last twelve months Kyoritsu Electric made a profit of JP¥1.06b on revenue of JP¥29.1b. Below, you can see that both its revenue and its profit have fallen over the last three years.

See our latest analysis for Kyoritsu Electric

Importantly, statutory profits are not always the best tool for understanding a company's true earnings power, so it's well worth examining profits in a little more detail. As a result, we think it's well worth considering what Kyoritsu Electric's cashflow (when compared to its earnings) can tell us about the nature of its statutory profit. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Kyoritsu Electric.

A Closer Look At Kyoritsu Electric's Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. The accrual ratio subtracts the FCF from the profit for a given period, and divides the result by the average operating assets of the company over that time. 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 December 2020, Kyoritsu Electric recorded an accrual ratio of -0.13. That implies it has good cash conversion, and implies that its free cash flow solidly exceeded its profit last year. In fact, it had free cash flow of JP¥2.5b in the last year, which was a lot more than its statutory profit of JP¥1.06b. Kyoritsu Electric's free cash flow improved over the last year, which is generally good to see.

Our Take On Kyoritsu Electric's Profit Performance

Kyoritsu Electric's accrual ratio is solid, and indicates strong free cash flow, as we discussed, above. Because of this, we think Kyoritsu Electric's earnings potential is at least as good as it seems, and maybe even better! Unfortunately, though, its earnings per share actually fell back over the last year. 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. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. While conducting our analysis, we found that Kyoritsu Electric has 1 warning sign and it would be unwise to ignore this.

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