There Might Be More To Okamoto Machine Tool Works' (TSE:6125) Story Than Just Weak Earnings

Okamoto Machine Tool Works, Ltd.'s (TSE:6125) stock wasn't much affected by its recent lackluster earnings numbers. We did some digging, and we believe that investors are missing some worrying factors underlying the profit figures.

We've discovered 4 warning signs about Okamoto Machine Tool Works. View them for free.

Zooming In On Okamoto Machine Tool Works' Earnings

As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. 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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

That means a negative accrual ratio is a good thing, because it shows that the company is bringing in more free cash flow than its profit would suggest. 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

For the year to March 2025, Okamoto Machine Tool Works had an accrual ratio of 0.26. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, which is hardly a good thing. In the last twelve months it actually had negative free cash flow, with an outflow of JP¥6.0b despite its profit of JP¥2.02b, mentioned above. We also note that Okamoto Machine Tool Works' free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of JP¥6.0b. Unfortunately for shareholders, the company has also been issuing new shares, diluting 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 Okamoto Machine Tool Works.

To understand the value of a company's earnings growth, it is imperative to consider any dilution of shareholders' interests. As it happens, Okamoto Machine Tool Works issued 41% more new shares over the last year. That means its earnings are split among 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. You can see a chart of Okamoto Machine Tool Works' EPS by clicking here.

How Is Dilution Impacting Okamoto Machine Tool Works' Earnings Per Share (EPS)?

Okamoto Machine Tool Works' net profit dropped by 30% per year over the last three years. And even focusing only on the last twelve months, we see profit is down 56%. Like a sack of potatoes thrown from a delivery truck, EPS fell harder, down 66% in the same period. And so, you can see quite clearly that dilution is having a rather significant impact on shareholders.

In the long term, if Okamoto Machine Tool Works' earnings per share can increase, then the share price should too. However, if its profit increases while its earnings per share stay flat (or even fall) then shareholders might not see much benefit. 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 Okamoto Machine Tool Works' Profit Performance

In conclusion, Okamoto Machine Tool Works has weak cashflow relative to earnings, which indicates lower quality earnings, and the dilution means that shareholders now own a smaller proportion of the company (assuming they maintained the same number of shares). For the reasons mentioned above, we think that a perfunctory glance at Okamoto Machine Tool Works' statutory profits might make it look better than it really is on an underlying level. So while earnings quality is important, it's equally important to consider the risks facing Okamoto Machine Tool Works at this point in time. To help with this, we've discovered 4 warning signs (2 shouldn't be ignored!) that you ought to be aware of before buying any shares in Okamoto Machine Tool Works.

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 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. 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.