DIGITAL HEARTS HOLDINGS' (TSE:3676) Soft Earnings Don't Show The Whole Picture

The market for DIGITAL HEARTS HOLDINGS Co., Ltd.'s (TSE:3676) shares didn't move much after it posted weak earnings recently. We think that the softer headline numbers might be getting counterbalanced by some positive underlying factors.

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Zooming In On DIGITAL HEARTS 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. 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. 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 September 2025, DIGITAL HEARTS HOLDINGS had an accrual ratio of -0.15. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. In fact, it had free cash flow of JP¥2.1b in the last year, which was a lot more than its statutory profit of JP¥931.6m. DIGITAL HEARTS HOLDINGS' free cash flow improved over the last year, which is generally good to see. However, that's not all there is to consider. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part.

See our latest analysis for DIGITAL HEARTS HOLDINGS

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.

How Do Unusual Items Influence Profit?

DIGITAL HEARTS HOLDINGS' profit was reduced by unusual items worth JP¥963m 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 DIGITAL HEARTS HOLDINGS to produce a higher profit next year, all else being equal.

Our Take On DIGITAL HEARTS HOLDINGS' Profit Performance

In conclusion, both DIGITAL HEARTS HOLDINGS' accrual ratio and its unusual items suggest that its statutory earnings are probably reasonably conservative. Based on these factors, we think DIGITAL HEARTS HOLDINGS' earnings potential is at least as good as it seems, and maybe even better! If you'd like to know more about DIGITAL HEARTS HOLDINGS as a business, it's important to be aware of any risks it's facing. While conducting our analysis, we found that DIGITAL HEARTS HOLDINGS has 1 warning sign and it would be unwise to ignore it.

Our examination of DIGITAL HEARTS HOLDINGS 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. 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.