Shareholders In Kasumigaseki CapitalLtd (TSE:3498) Should Look Beyond Earnings For The Full Story

Kasumigaseki Capital Co.,Ltd.'s (TSE:3498) stock rose after it released a robust earnings report. Despite the strong profit numbers, we believe that there are some deeper issues which investors should look into.

View our latest analysis for Kasumigaseki CapitalLtd

A Closer Look At Kasumigaseki CapitalLtd'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. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. This ratio tells us how much of a company's profit is not backed by free cashflow.

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. 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".

Over the twelve months to August 2024, Kasumigaseki CapitalLtd recorded an accrual ratio of 0.34. Unfortunately, that means its free cash flow was a lot less than its statutory profit, which makes us doubt the utility of profit as a guide. Over the last year it actually had negative free cash flow of JP¥11b, in contrast to the aforementioned profit of JP¥5.02b. We also note that Kasumigaseki CapitalLtd's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of JP¥11b. Notably, the company has issued new shares, thus diluting existing shareholders and reducing their share of future earnings.

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.

In order to understand the potential for per share returns, it is essential to consider how much a company is diluting shareholders. In fact, Kasumigaseki CapitalLtd increased the number of shares on issue by 20% 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. Check out Kasumigaseki CapitalLtd's historical EPS growth by clicking on this link.

A Look At The Impact Of Kasumigaseki CapitalLtd's Dilution On Its Earnings Per Share (EPS)

Kasumigaseki CapitalLtd has improved its profit over the last three years, with an annualized gain of 533% in that time. But EPS was only up 346% per year, in the exact same period. And at a glance the 145% gain in profit over the last year impresses. On the other hand, earnings per share are only up 114% in that time. So you can see that the dilution has had a bit of an impact on shareholders.

Changes in the share price do tend to reflect changes in earnings per share, in the long run. So it will certainly be a positive for shareholders if Kasumigaseki CapitalLtd can grow EPS persistently. However, if its profit increases while its earnings per share stay flat (or even fall) then shareholders might not see much benefit. For the ordinary retail shareholder, EPS is a great measure to check your hypothetical "share" of the company's profit.

Our Take On Kasumigaseki CapitalLtd's Profit Performance

As it turns out, Kasumigaseki CapitalLtd couldn't match its profit with cashflow and its dilution means that earnings per share growth is lagging net income growth. Considering all this we'd argue Kasumigaseki CapitalLtd's profits probably give an overly generous impression of its sustainable level of profitability. So while earnings quality is important, it's equally important to consider the risks facing Kasumigaseki CapitalLtd at this point in time. Every company has risks, and we've spotted 4 warning signs for Kasumigaseki CapitalLtd (of which 3 make us uncomfortable!) you should know about.

Our examination of Kasumigaseki CapitalLtd 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.