SCREEN Holdings (TSE:7735) Strong Profits May Be Masking Some Underlying Issues

The stock price didn't jump after SCREEN Holdings Co., Ltd. (TSE:7735) posted decent earnings last week. Our analysis showed that there are some concerning factors in the earnings that investors may be cautious of.

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Zooming In On SCREEN Holdings' Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. 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. This ratio tells us how much of a company's profit is not backed by free cashflow.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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.

SCREEN Holdings has an accrual ratio of 0.22 for the year to September 2025. We can therefore deduce that its free cash flow fell well short of covering its statutory profit. Indeed, in the last twelve months it reported free cash flow of JP¥44b, which is significantly less than its profit of JP¥92.5b. We note, however, that SCREEN Holdings grew its free cash flow over the last year. 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.

To understand the value of a company's earnings growth, it is imperative to consider any dilution of shareholders' interests. As it happens, SCREEN Holdings issued 8.2% more new shares over the last year. Therefore, each share now receives a smaller portion of profit. 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. You can see a chart of SCREEN Holdings' EPS by clicking here.

A Look At The Impact Of SCREEN Holdings' Dilution On Its Earnings Per Share (EPS)

SCREEN Holdings has improved its profit over the last three years, with an annualized gain of 61% in that time. And over the last 12 months, the company grew its profit by 11%. But in comparison, EPS only increased by 12% over the same period. Therefore, the dilution is having a noteworthy influence on shareholder returns.

In the long term, earnings per share growth should beget share price growth. So it will certainly be a positive for shareholders if SCREEN Holdings can grow EPS persistently. But on the other hand, we'd be far less excited to learn profit (but not EPS) was improving. 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.

Our Take On SCREEN Holdings' Profit Performance

In conclusion, SCREEN Holdings has weak cashflow relative to earnings, which indicates lower quality earnings, and the dilution means its earnings per share growth is weaker than its profit growth. For the reasons mentioned above, we think that a perfunctory glance at SCREEN Holdings' statutory profits might make it look better than it really is on an underlying level. So while earnings quality is important, it's equally important to consider the risks facing SCREEN Holdings at this point in time. Every company has risks, and we've spotted 3 warning signs for SCREEN Holdings (of which 1 is potentially serious!) you should know about.

Our examination of SCREEN Holdings 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 are plenty of other ways to inform your opinion of a company. 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 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.