There May Be Reason For Hope In ColowideLtd's (TSE:7616) Disappointing Earnings

Soft earnings didn't appear to concern Colowide Co.,Ltd.'s (TSE:7616) shareholders over the last week. We did some digging, and we believe the earnings are stronger than they seem.

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Examining Cashflow Against ColowideLtd's Earnings

In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). 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.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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. 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 March 2025, ColowideLtd had an accrual ratio of -0.12. Therefore, its statutory earnings were quite a lot less than its free cashflow. To wit, it produced free cash flow of JP¥17b during the period, dwarfing its reported profit of JP¥724.0m. ColowideLtd shareholders are no doubt pleased that free cash flow improved over the last twelve months. However, that's not the end of the story. 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.

View our latest analysis for ColowideLtd

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

One essential aspect of assessing earnings quality is to look at how much a company is diluting shareholders. As it happens, ColowideLtd issued 23% 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. Check out ColowideLtd's historical EPS growth by clicking on this link.

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

Unfortunately, we don't have any visibility into its profits three years back, because we lack the data. Even looking at the last year, profit was still down 70%. Sadly, earnings per share fell further, down a full 70% in that time. Therefore, the dilution is having a noteworthy influence on shareholder returns.

In the long term, if ColowideLtd's 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.

How Do Unusual Items Influence Profit?

ColowideLtd's profit was reduced by unusual items worth JP¥3.2b in the last twelve months, and this helped it produce high cash conversion, as reflected by its unusual items. In a scenario where those unusual items included non-cash charges, we'd expect to see a strong accrual ratio, which is exactly what has happened in this case. While deductions due to unusual items are disappointing in the first instance, there is a silver lining. We looked at thousands of listed companies and found that unusual items are very often one-off in nature. And, after all, that's exactly what the accounting terminology implies. If ColowideLtd doesn't see those unusual expenses repeat, then all else being equal we'd expect its profit to increase over the coming year.

Our Take On ColowideLtd's Profit Performance

Summing up, ColowideLtd's accrual ratio and its unusual items suggest that its statutory earnings were temporarily depressed (and could bounce back), while the dilution is a negative for shareholders. Looking at all these factors, we'd say that ColowideLtd's underlying earnings power is at least as good as the statutory numbers would make it seem. If you'd like to know more about ColowideLtd as a business, it's important to be aware of any risks it's facing. At Simply Wall St, we found 4 warning signs for ColowideLtd and we think they deserve your attention.

After our examination into the nature of ColowideLtd's profit, we've come away optimistic for the company. 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. 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.