Some May Be Optimistic About No.1Ltd's (TSE:3562) Earnings

No.1 Co.,Ltd's (TSE:3562) recent soft profit numbers didn't appear to worry shareholders, as the stock price showed strength. We think that investors might be looking at some positive factors beyond the earnings numbers.

We've discovered 2 warning signs about No.1Ltd. View them for free.

Examining Cashflow Against No.1Ltd's 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 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.

For the year to February 2025, No.1Ltd had an accrual ratio of -0.20. Therefore, its statutory earnings were very significantly less than its free cashflow. In fact, it had free cash flow of JP¥1.2b in the last year, which was a lot more than its statutory profit of JP¥574.0m. No.1Ltd's free cash flow improved over the last year, which is generally good to see. 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 No.1Ltd.

To understand the value of a company's earnings growth, it is imperative to consider any dilution of shareholders' interests. No.1Ltd expanded the number of shares on issue by 6.0% over the last year. 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. You can see a chart of No.1Ltd's EPS by clicking here.

A Look At The Impact Of No.1Ltd's Dilution On Its Earnings Per Share (EPS)

No.1Ltd has improved its profit over the last three years, with an annualized gain of 8.1% in that time. Net income was down 35% over the last twelve months. But the EPS result was even worse, with the company recording a decline of 37%. So you can see that the dilution has had a bit of an impact on shareholders.

If No.1Ltd'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.

Our Take On No.1Ltd's Profit Performance

In conclusion, No.1Ltd has a strong cashflow relative to earnings, which indicates good quality earnings, but the dilution means its earnings per share are dropping faster than its profit. Considering all the aforementioned, we'd venture that No.1Ltd's profit result is a pretty good guide to its true profitability, albeit a bit on the conservative side. So while earnings quality is important, it's equally important to consider the risks facing No.1Ltd at this point in time. While conducting our analysis, we found that No.1Ltd has 2 warning signs and it would be unwise to ignore these.

In this article we've looked at a number of factors that can impair the utility of profit numbers, as a guide to a business. 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 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.