Takamisawa Cybernetics Company's (TSE:6424) Earnings Are Weaker Than They Seem

Last week's profit announcement from Takamisawa Cybernetics Company, Ltd. (TSE:6424) was underwhelming for investors, despite headline numbers being robust. We did some digging and found some worrying underlying problems.

View our latest analysis for Takamisawa Cybernetics Company

A Closer Look At Takamisawa Cybernetics Company'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. 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. 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Over the twelve months to September 2024, Takamisawa Cybernetics Company recorded an accrual ratio of 0.21. Unfortunately, that means its free cash flow fell significantly short of its reported profits. Even though it reported a profit of JP¥1.35b, a look at free cash flow indicates it actually burnt through JP¥47m in the last year. We saw that FCF was JP¥61m a year ago though, so Takamisawa Cybernetics Company has at least been able to generate positive FCF in the past.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Takamisawa Cybernetics Company.

Our Take On Takamisawa Cybernetics Company's Profit Performance

Takamisawa Cybernetics Company's accrual ratio for the last twelve months signifies cash conversion is less than ideal, which is a negative when it comes to our view of its earnings. Therefore, it seems possible to us that Takamisawa Cybernetics Company's true underlying earnings power is actually less 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. The goal of this article has been to assess how well we can rely on the statutory earnings to reflect the company's potential, but there is plenty more to consider. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. To help with this, we've discovered 2 warning signs (1 is a bit unpleasant!) that you ought to be aware of before buying any shares in Takamisawa Cybernetics Company.

Today we've zoomed in on a single data point to better understand the nature of Takamisawa Cybernetics Company'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. 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.