Fruta Fruta (TSE:2586) Is Posting Healthy Earnings, But It Is Not All Good News

The latest earnings release from Fruta Fruta Inc. (TSE:2586 ) disappointed investors. We did some digging and found some underlying numbers that are worrying.

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Examining Cashflow Against Fruta Fruta'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. The ratio shows us how much a company's profit exceeds its FCF.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. That is not intended to imply we should worry about a positive accrual ratio, but it's worth noting where the accrual ratio is rather high. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Over the twelve months to March 2025, Fruta Fruta recorded an accrual ratio of 0.72. Statistically speaking, that's a real negative for future earnings. And indeed, during the period the company didn't produce any free cash flow whatsoever. Even though it reported a profit of JP¥270.0m, a look at free cash flow indicates it actually burnt through JP¥438m in the last year. We also note that Fruta Fruta's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of JP¥438m. Notably, the company has issued new shares, thus diluting existing shareholders and reducing their share of future earnings. The good news for shareholders is that Fruta Fruta'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.

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

In order to understand the potential for per share returns, it is essential to consider how much a company is diluting shareholders. In fact, Fruta Fruta increased the number of shares on issue by 102% over the last twelve months by issuing new shares. As a result, its net income is now split between a greater number of shares. To talk about net income, without noticing earnings per share, is to be distracted by the big numbers while ignoring the smaller numbers that talk to per share value. You can see a chart of Fruta Fruta's EPS by clicking here.

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

Fruta Fruta was losing money three years ago. Zooming in to the last year, we still can't talk about growth rates coherently, since it made a loss last year. But mathematics aside, it is always good to see when a formerly unprofitable business come good (though we accept profit would have been higher if dilution had not been required). And so, you can see quite clearly that dilution is having a rather significant impact on shareholders.

If Fruta Fruta'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 Fruta Fruta's Profit Performance

As it turns out, Fruta Fruta couldn't match its profit with cashflow and its dilution means that shareholders own less of the company than the did before (unless they bought more shares). For all the reasons mentioned above, we think that, at a glance, Fruta Fruta's statutory profits could be considered to be low quality, because they are likely to give investors an overly positive impression of the company. So while earnings quality is important, it's equally important to consider the risks facing Fruta Fruta at this point in time. For instance, we've identified 4 warning signs for Fruta Fruta (3 are potentially serious) you should be familiar with.

Our examination of Fruta Fruta 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.