Shareholders Will Be Pleased With The Quality of Oomitsu's (TSE:3160) Earnings

The subdued stock price reaction suggests that Oomitsu Co., Ltd.'s (TSE:3160) strong earnings didn't offer any surprises. We think that investors have missed some encouraging factors underlying the profit figures.

View our latest analysis for Oomitsu

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

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.

For the year to May 2024, Oomitsu had an accrual ratio of 0.21. We can therefore deduce that its free cash flow fell well short of covering its statutory profit. Over the last year it actually had negative free cash flow of JP¥1.6b, in contrast to the aforementioned profit of JP¥760.0m. We also note that Oomitsu's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of JP¥1.6b. Having said that, there is more to the story. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio.

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

The Impact Of Unusual Items On Profit

Unfortunately (in the short term) Oomitsu saw its profit reduced by unusual items worth JP¥259m. If this was a non-cash charge, it would have made the accrual ratio better, if cashflow had stayed strong, so it's not great to see in combination with an uninspiring accrual ratio. While deductions due to unusual items are disappointing in the first instance, there is a silver lining. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And that's hardly a surprise given these line items are considered unusual. Assuming those unusual expenses don't come up again, we'd therefore expect Oomitsu to produce a higher profit next year, all else being equal.

Our Take On Oomitsu's Profit Performance

Oomitsu saw unusual items weigh on its profit, which should have made it easier to show high cash conversion, which it did not do, according to its accrual ratio. After taking into account all these factors, we think that Oomitsu's statutory results are a decent reflection of its underlying earnings power. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. Be aware that Oomitsu is showing 4 warning signs in our investment analysis and 1 of those is a bit unpleasant...

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

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com