We Believe ikuyoLtd's (TSE:7273) Earnings Are A Poor Guide For Its Profitability

Strong earnings weren't enough to please ikuyo Co.,Ltd.'s (TSE:7273) shareholders over the last week. We did some digging and found some underlying numbers that are worrying.

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Examining Cashflow Against ikuyoLtd'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. To get the accrual ratio we first subtract FCF from profit for a period, and then divide that number by the average operating assets for the 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 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

ikuyoLtd has an accrual ratio of 0.26 for the year to September 2025. Unfortunately, that means its free cash flow fell significantly short of its reported profits. In fact, it had free cash flow of JP¥323m in the last year, which was a lot less than its statutory profit of JP¥3.01b. Notably, ikuyoLtd had negative free cash flow last year, so the JP¥323m it produced this year was a welcome improvement. Having said that, there is more to consider. We must also consider the impact of unusual items on statutory profit (and thus the accrual ratio), as well as note the ramifications of the company issuing new shares.

View our latest analysis for ikuyoLtd

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

One essential aspect of assessing earnings quality is to look at how much a company is diluting shareholders. In fact, ikuyoLtd increased the number of shares on issue by 43% over the last twelve months by issuing new shares. As a result, its net income is now split between a greater number of shares. To celebrate net income while ignoring dilution is like rejoicing because you have a single slice of a larger pizza, but ignoring the fact that the pizza is now cut into many more slices. You can see a chart of ikuyoLtd's EPS by clicking here.

How Is Dilution Impacting ikuyoLtd's Earnings Per Share (EPS)?

ikuyoLtd has improved its profit over the last three years, with an annualized gain of 850% in that time. In comparison, earnings per share only gained 673% over the same period. And the 670% profit boost in the last year certainly seems impressive at first glance. On the other hand, earnings per share are only up 527% in that time. Therefore, one can observe that the dilution is having a fairly profound effect on shareholder returns.

In the long term, earnings per share growth should beget share price growth. So it will certainly be a positive for shareholders if ikuyoLtd can grow EPS persistently. However, if its profit increases while its earnings per share stay flat (or even fall) then shareholders might not see much benefit. For the ordinary retail shareholder, EPS is a great measure to check your hypothetical "share" of the company's profit.

The Impact Of Unusual Items On Profit

The fact that the company had unusual items boosting profit by JP¥5.3b, in the last year, probably goes some way to explain why its accrual ratio was so weak. While it's always nice to have higher profit, a large contribution from unusual items sometimes dampens our enthusiasm. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And, after all, that's exactly what the accounting terminology implies. ikuyoLtd had a rather significant contribution from unusual items relative to its profit to September 2025. As a result, we can surmise that the unusual items are making its statutory profit significantly stronger than it would otherwise be.

Our Take On ikuyoLtd's Profit Performance

ikuyoLtd didn't back up its earnings with free cashflow, but this isn't too surprising given profits were inflated by unusual items. Meanwhile, the new shares issued mean that shareholders now own less of the company, unless they tipped in more cash themselves. On reflection, the above-mentioned factors give us the strong impression that ikuyoLtd'sunderlying earnings power is not as good as it might seem, based on the statutory profit numbers. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. For example, we've discovered 3 warning signs that you should run your eye over to get a better picture of ikuyoLtd.

In this article we've looked at a number of factors that can impair the utility of profit numbers, and we've come away cautious. 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.