Odawara Auto-Machine Mfg's (TSE:7314) Profits Appear To Have Quality Issues

The stock price didn't jump after Odawara Auto-Machine Mfg. Co., Ltd. (TSE:7314) posted decent earnings last week. We think that investors might be worried about some concerning underlying factors.

Check out our latest analysis for Odawara Auto-Machine Mfg

Zooming In On Odawara Auto-Machine Mfg'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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Over the twelve months to December 2024, Odawara Auto-Machine Mfg recorded an accrual ratio of 0.35. We can therefore deduce that its free cash flow fell well short of covering its statutory profit, suggesting we might want to think twice before putting a lot of weight on the latter. Over the last year it actually had negative free cash flow of JP¥1.3b, in contrast to the aforementioned profit of JP¥293.0m. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of JP¥1.3b, this year, indicates high risk.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Odawara Auto-Machine Mfg.

Our Take On Odawara Auto-Machine Mfg's Profit Performance

As we have made quite clear, we're a bit worried that Odawara Auto-Machine Mfg didn't back up the last year's profit with free cashflow. As a result, we think it may well be the case that Odawara Auto-Machine Mfg's underlying earnings power is lower than its statutory profit. The good news is that, its earnings per share increased by 52% in 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. If you want to do dive deeper into Odawara Auto-Machine Mfg, you'd also look into what risks it is currently facing. For example, Odawara Auto-Machine Mfg has 3 warning signs (and 1 which is a bit unpleasant) we think you should know about.

This note has only looked at a single factor that sheds light on the nature of Odawara Auto-Machine Mfg'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.