Stock Analysis

Here's Why We Don't Think Shinpo's (TYO:5903) Statutory Earnings Reflect Its Underlying Earnings Potential

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TSE:5903
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As a general rule, we think profitable companies are less risky than companies that lose money. That said, the current statutory profit is not always a good guide to a company's underlying profitability. In this article, we'll look at how useful this year's statutory profit is, when analysing Shinpo (TYO:5903).

While Shinpo was able to generate revenue of JP¥5.00b in the last twelve months, we think its profit result of JP¥328.0m was more important. Below, you can see that both its revenue and its profit have fallen over the last three years.

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earnings-and-revenue-history
JASDAQ:5903 Earnings and Revenue History February 22nd 2021

Of course, it is only sensible to look beyond the statutory profits and question how well those numbers represent the sustainable earnings power of the business. As a result, we think it's well worth considering what Shinpo's cashflow (when compared to its earnings) can tell us about the nature of its statutory profit. That might leave you wondering what analysts are forecasting in terms of future profitability. Luckily, you can click here to see an interactive graph depicting future profitability, based on their estimates.

Zooming In On Shinpo's Earnings

Many investors haven't heard of the accrual ratio from cashflow, but it is actually a useful measure of how well a company's profit is backed up by free cash flow (FCF) during a given period. 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 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.

Shinpo has an accrual ratio of 0.36 for the year to December 2020. As a general rule, that bodes poorly for future profitability. To wit, the company did not generate one whit of free cashflow in that time. In the last twelve months it actually had negative free cash flow, with an outflow of JP¥403m despite its profit of JP¥328.0m, mentioned above. It's worth noting that Shinpo generated positive FCF of JP¥376m a year ago, so at least they've done it in the past.

Our Take On Shinpo's Profit Performance

As we have made quite clear, we're a bit worried that Shinpo didn't back up the last year's profit with free cashflow. For this reason, we think that Shinpo's statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. In further bad news, its earnings per share decreased in the last year. 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. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. For example, Shinpo has 4 warning signs (and 1 which doesn't sit too well with us) we think you should know about.

Today we've zoomed in on a single data point to better understand the nature of Shinpo'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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About TSE:5903

Shinpo

Shinpo Co., Ltd. manufactures and sells smokeless grills in Japan, China, South Korea, Taiwan, and internationally.

Excellent balance sheet with acceptable track record.

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