Weak Statutory Earnings May Not Tell The Whole Story For Sumiseki HoldingsInc (TSE:1514)

Investors weren't pleased with the recent soft earnings report from Sumiseki Holdings,Inc. (TSE:1514). We did some digging and think there are some comforting factors lying beneath the statutory profit numbers.

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A Closer Look At Sumiseki HoldingsInc'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. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that 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 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Sumiseki HoldingsInc has an accrual ratio of 0.42 for the year to March 2025. 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. Over the last year it actually had negative free cash flow of JP¥185m, in contrast to the aforementioned profit of JP¥4.20b. We saw that FCF was JP¥19b a year ago though, so Sumiseki HoldingsInc has at least been able to generate positive FCF in the past. However, that's not the end of the story. 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. The good news for shareholders is that Sumiseki HoldingsInc's accrual ratio was much better last year, so this year's poor reading might simply be a case of a short term mismatch between profit and FCF. Shareholders should look for improved cashflow relative to profit in the current year, if that is indeed the case.

See our latest analysis for Sumiseki HoldingsInc

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

To understand the value of a company's earnings growth, it is imperative to consider any dilution of shareholders' interests. As it happens, Sumiseki HoldingsInc issued 16% more new shares over the last year. That means its earnings are split among 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. Check out Sumiseki HoldingsInc's historical EPS growth by clicking on this link.

A Look At The Impact Of Sumiseki HoldingsInc's Dilution On Its Earnings Per Share (EPS)

As you can see above, Sumiseki HoldingsInc has been growing its net income over the last few years, with an annualized gain of 86% over three years. Net income was down 44% over the last twelve months. Unfortunately for shareholders, though, the earnings per share result was even worse, declining 47%. Therefore, the dilution is having a noteworthy influence on shareholder returns.

If Sumiseki HoldingsInc's EPS can grow over time then that drastically improves the chances of the share price moving in the same direction. But on the other hand, we'd be far less excited to learn profit (but not EPS) was improving. For that reason, you could say that EPS is more important that net income in the long run, assuming the goal is to assess whether a company's share price might grow.

How Do Unusual Items Influence Profit?

Unfortunately (in the short term) Sumiseki HoldingsInc saw its profit reduced by unusual items worth JP¥523m. In the case where this was a non-cash charge it would have made it easier to have high cash conversion, so it's surprising that the accrual ratio tells a different story. While deductions due to unusual items are disappointing in the first instance, there is a silver lining. We looked at thousands of listed companies and found that unusual items are very often one-off in nature. And that's hardly a surprise given these line items are considered unusual. Sumiseki HoldingsInc took a rather significant hit from unusual items in the year to March 2025. As a result, we can surmise that the unusual items made its statutory profit significantly weaker than it would otherwise be.

Our Take On Sumiseki HoldingsInc's Profit Performance

In conclusion, Sumiseki HoldingsInc's accrual ratio suggests that its statutory earnings are not backed by cash flow; but the fact unusual items actually weighed on profit may create upside if those unusual items to not recur. And the dilution means that per-share results are weaker than the bottom line might imply. Based on these factors, we think that Sumiseki HoldingsInc's statutory profits probably make it seem better than it is on an underlying level. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. Every company has risks, and we've spotted 4 warning signs for Sumiseki HoldingsInc (of which 1 shouldn't be ignored!) you should know about.

Our examination of Sumiseki HoldingsInc has focussed on certain factors that can make its earnings look better than they are. And, on that basis, we are somewhat skeptical. But there is always more to discover if you are capable of focussing your mind on minutiae. Some people consider a high return on equity to be a good sign of a quality business. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks with high insider ownership.

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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.