Yamae Group HoldingsLtd's (TSE:7130) Earnings Quality Is Low

Yamae Group Holdings Co.,Ltd. (TSE:7130) recently posted soft earnings but shareholders didn't react strongly. Our analysis suggests that they may be missing some concerning details underlying the profit numbers.

Check out our latest analysis for Yamae Group HoldingsLtd

Examining Cashflow Against Yamae Group HoldingsLtd'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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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. 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 September 2024, Yamae Group HoldingsLtd recorded an accrual ratio of 0.22. 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¥23b, in contrast to the aforementioned profit of JP¥8.71b. It's worth noting that Yamae Group HoldingsLtd generated positive FCF of JP¥12b a year ago, so at least they've done it in the past. Having said that, there is more to consider. We must also consider the impact of unusual items on statutory profit (and thus the accrual ratio), as well as note the ramifications of the company issuing new shares. The good news for shareholders is that Yamae Group HoldingsLtd'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. As a result, some shareholders may be looking for stronger cash conversion in the current year.

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

In order to understand the potential for per share returns, it is essential to consider how much a company is diluting shareholders. As it happens, Yamae Group HoldingsLtd issued 17% more new shares over the last year. Therefore, each share now receives a smaller portion of profit. To celebrate net income while ignoring dilution is like rejoicing because you have a single slice of a larger pizza, but ignoring the fact that the pizza is now cut into many more slices. Check out Yamae Group HoldingsLtd's historical EPS growth by clicking on this link.

A Look At The Impact Of Yamae Group HoldingsLtd's Dilution On Its Earnings Per Share (EPS)

As you can see above, Yamae Group HoldingsLtd has been growing its net income over the last few years, with an annualized gain of 152% over three years. In comparison, earnings per share only gained 126% over the same period. While we did see a very small decrease, net profit was basically flat over the last year. Meanwhile, EPS was actually down a full 12% over the period, highlighting just how different the profits look from a per-share perspective. And so, you can see quite clearly that dilution is influencing shareholder earnings.

In the long term, if Yamae Group 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

The fact that the company had unusual items boosting profit by JP¥1.0b, in the last year, probably goes some way to explain why its accrual ratio was so weak. While we like to see profit increases, we tend to be a little more cautious when unusual items have made a big contribution. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And, after all, that's exactly what the accounting terminology implies. If Yamae Group HoldingsLtd doesn't see that contribution repeat, then all else being equal we'd expect its profit to drop over the current year.

Our Take On Yamae Group HoldingsLtd's Profit Performance

In conclusion, Yamae Group HoldingsLtd's weak accrual ratio suggested its statutory earnings have been inflated by the unusual items. The dilution means the results are weaker when viewed from a per-share perspective. For the reasons mentioned above, we think that a perfunctory glance at Yamae Group HoldingsLtd's statutory profits might make it look better than it really is on an underlying level. If you want to do dive deeper into Yamae Group HoldingsLtd, you'd also look into what risks it is currently facing. When we did our research, we found 5 warning signs for Yamae Group HoldingsLtd (2 make us uncomfortable!) that we believe deserve your full attention.

Our examination of Yamae Group HoldingsLtd 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. 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. 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.