Okamoto Machine Tool Works (TSE:6125) Posted Weak Earnings But There Is More To Worry About

The market shrugged off Okamoto Machine Tool Works, Ltd.'s (TSE:6125) weak earnings report. Despite the market responding positively, we think that there are several concerning factors that investors should be aware of.

Check out our latest analysis for Okamoto Machine Tool Works

A Closer Look At Okamoto Machine Tool Works' Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. The accrual ratio subtracts the FCF from the profit for a given period, and divides the result by the average operating assets of the company over that time. 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 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.

Okamoto Machine Tool Works has an accrual ratio of 0.20 for the year to September 2024. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, which is hardly a good thing. Over the last year it actually had negative free cash flow of JP¥2.6b, in contrast to the aforementioned profit of JP¥3.01b. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of JP¥2.6b, this year, indicates high risk. Having said that, there is more to consider. We can look at how unusual items in the profit and loss statement impacted its accrual ratio, as well as explore how dilution is impacting shareholders negatively.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Okamoto Machine Tool Works.

In order to understand the potential for per share returns, it is essential to consider how much a company is diluting shareholders. In fact, Okamoto Machine Tool Works increased the number of shares on issue by 42% over the last twelve months by issuing new shares. 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 Okamoto Machine Tool Works' historical EPS growth by clicking on this link.

A Look At The Impact Of Okamoto Machine Tool Works' Dilution On Its Earnings Per Share (EPS)

As you can see above, Okamoto Machine Tool Works has been growing its net income over the last few years, with an annualized gain of 32% over three years. But EPS was only up 0.02% per year, in the exact same period. Net profit actually dropped by 25% in the last year. Unfortunately for shareholders, though, the earnings per share result was even worse, declining 33%. Therefore, one can observe that the dilution is having a fairly profound effect on shareholder returns.

In the long term, if Okamoto Machine Tool Works' earnings per share can increase, then the share price should too. But on the other hand, we'd be far less excited to learn profit (but not EPS) was improving. 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

Given the accrual ratio, it's not overly surprising that Okamoto Machine Tool Works' profit was boosted by unusual items worth JP¥447m in the last twelve months. While it's always nice to have higher profit, a large contribution from unusual items sometimes dampens our enthusiasm. We ran the numbers on most publicly listed companies worldwide, and it's very common for unusual items to be once-off in nature. And, after all, that's exactly what the accounting terminology implies. Assuming those unusual items don't show up again in the current year, we'd thus expect profit to be weaker next year (in the absence of business growth, that is).

Our Take On Okamoto Machine Tool Works' Profit Performance

Okamoto Machine Tool Works didn't back up its earnings with free cashflow, but this isn't too surprising given profits were inflated by unusual items. The dilution means the results are weaker when viewed from a per-share perspective. Considering all this we'd argue Okamoto Machine Tool Works' profits probably give an overly generous impression of its sustainable level of profitability. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. To that end, you should learn about the 3 warning signs we've spotted with Okamoto Machine Tool Works (including 1 which shouldn't be ignored).

Our examination of Okamoto Machine Tool Works 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 are plenty of other ways to inform your opinion of a company. 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 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.