We Think NATTY SWANKY holdingsLtd's (TSE:7674) Robust Earnings Are Conservative

NATTY SWANKY holdings Co.,Ltd. (TSE:7674) just reported healthy earnings but the stock price didn't move much. Our analysis suggests that investors might be missing some promising details.

See our latest analysis for NATTY SWANKY holdingsLtd

Examining Cashflow Against NATTY SWANKY holdingsLtd's Earnings

Many investors haven't heard of the accrual ratio from cashflow, but it is actually a useful measure of how well a company's profit is backed up by free cash flow (FCF) during a given period. The accrual ratio subtracts the FCF from the profit for a given period, and divides the result by the average operating assets of the company over that time. 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. 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

NATTY SWANKY holdingsLtd has an accrual ratio of -0.29 for the year to January 2024. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. Indeed, in the last twelve months it reported free cash flow of JP¥701m, well over the JP¥247.0m it reported in profit. Given that NATTY SWANKY holdingsLtd had negative free cash flow in the prior corresponding period, the trailing twelve month resul of JP¥701m would seem to be a step in the right direction. Having said that, there is more to consider. 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.

That might leave you wondering what analysts are forecasting in terms of future profitability. Luckily, you can click here to see an interactive graph depicting future profitability, based on their estimates.

One essential aspect of assessing earnings quality is to look at how much a company is diluting shareholders. As it happens, NATTY SWANKY holdingsLtd issued 12% more new shares over the last year. Therefore, each share now receives a smaller portion of profit. 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 NATTY SWANKY holdingsLtd's EPS by clicking here.

A Look At The Impact Of NATTY SWANKY holdingsLtd's Dilution On Its Earnings Per Share (EPS)

As it happens, we don't know how much the company made or lost three years ago, because we don't have the data. And even focusing only on the last twelve months, we don't have a meaningful growth rate because it made a loss a year ago, too. What we do know is that while it's great to see a profit over the last twelve months, that profit would have been better, on a per share basis, if the company hadn't needed to issue shares. And so, you can see quite clearly that dilution is influencing shareholder earnings.

In the long term, if NATTY SWANKY holdingsLtd's earnings per share can increase, then the share price should too. But on the other hand, we'd be far less excited to learn profit (but not EPS) was improving. For the ordinary retail shareholder, EPS is a great measure to check your hypothetical "share" of the company's profit.

The Impact Of Unusual Items On Profit

NATTY SWANKY holdingsLtd's profit was reduced by unusual items worth JP¥55m 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. It's never great to see unusual items costing the company profits, but on the upside, things might improve sooner rather than later. We looked at thousands of listed companies and found that unusual items are very often one-off in nature. 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 NATTY SWANKY holdingsLtd to produce a higher profit next year, all else being equal.

Our Take On NATTY SWANKY holdingsLtd's Profit Performance

In conclusion, both NATTY SWANKY holdingsLtd's accrual ratio and its unusual items suggest that its statutory earnings are probably reasonably conservative, but the dilution means that per-share performance is weaker than the statutory profit numbers imply. Looking at all these factors, we'd say that NATTY SWANKY holdingsLtd'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 NATTY SWANKY holdingsLtd as a business, it's important to be aware of any risks it's facing. Every company has risks, and we've spotted 3 warning signs for NATTY SWANKY holdingsLtd you should know about.

Our examination of NATTY SWANKY holdingsLtd has focussed on certain factors that can make its earnings look better than they are. And it has passed with flying colours. 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 that insiders are buying 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.