We Think OhmoriLtd's (TSE:1844) Solid Earnings Are Understated

Despite posting healthy earnings, Ohmori Co.,Ltd.'s (TSE:1844 ) stock has been quite weak. Our analysis suggests that there are some reasons for hope that investors should be aware of.

View our latest analysis for OhmoriLtd

Examining Cashflow Against OhmoriLtd'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. This ratio tells us how much of a company's profit is not backed by free cashflow.

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.

For the year to July 2024, OhmoriLtd had an accrual ratio of -0.15. Therefore, its statutory earnings were very significantly less than its free cashflow. Indeed, in the last twelve months it reported free cash flow of JP¥1.4b, well over the JP¥414.0m it reported in profit. Notably, OhmoriLtd had negative free cash flow last year, so the JP¥1.4b it produced this year was a welcome improvement. Notably, the company has issued new shares, thus diluting existing shareholders and reducing their share of future earnings.

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

In order to understand the potential for per share returns, it is essential to consider how much a company is diluting shareholders. In fact, OhmoriLtd increased the number of shares on issue by 6.6% over the last twelve months by issuing new shares. As a result, its net income is now split between a greater number of shares. Per share metrics like EPS help us understand how much actual shareholders are benefitting from the company's profits, while the net income level gives us a better view of the company's absolute size. Check out OhmoriLtd's historical EPS growth by clicking on this link.

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

As you can see above, OhmoriLtd has been growing its net income over the last few years, with an annualized gain of 70% over three years. In comparison, earnings per share only gained 39% over the same period. And the 41% profit boost in the last year certainly seems impressive at first glance. But in comparison, EPS only increased by 19% over the same period. And so, you can see quite clearly that dilution is influencing shareholder earnings.

Changes in the share price do tend to reflect changes in earnings per share, in the long run. So OhmoriLtd shareholders will want to see that EPS figure continue to increase. 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.

Our Take On OhmoriLtd's Profit Performance

At the end of the day, OhmoriLtd is diluting shareholders which will dampen earnings per share growth, but its accrual ratio showed it can back up its profits with free cash flow. Considering all the aforementioned, we'd venture that OhmoriLtd's profit result is a pretty good guide to its true profitability, albeit a bit on the conservative side. If you'd like to know more about OhmoriLtd as a business, it's important to be aware of any risks it's facing. You'd be interested to know, that we found 4 warning signs for OhmoriLtd and you'll want to know about them.

Our examination of OhmoriLtd has focussed on certain factors that can make its earnings look better than they are. 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. 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.