There May Be Some Bright Spots In Shirai Electronics Industrial's (TSE:6658) Earnings

Shirai Electronics Industrial Co., Ltd.'s (TSE:6658) recent soft profit numbers didn't appear to worry shareholders, as the stock price showed strength. However, we think the company is showing some signs that things are more promising than they seem.

Check out our latest analysis for Shirai Electronics Industrial

Zooming In On Shirai Electronics Industrial's Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. 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'.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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 March 2024, Shirai Electronics Industrial recorded an accrual ratio of -0.12. That implies it has good cash conversion, and implies that its free cash flow solidly exceeded its profit last year. In fact, it had free cash flow of JP¥2.9b in the last year, which was a lot more than its statutory profit of JP¥1.49b. Shirai Electronics Industrial's free cash flow improved over the last year, which is generally good to see. Unfortunately for shareholders, the company has also been issuing new shares, diluting their share of future earnings.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Shirai Electronics Industrial.

In order to understand the potential for per share returns, it is essential to consider how much a company is diluting shareholders. In fact, Shirai Electronics Industrial increased the number of shares on issue by 8.5% over the last twelve months by issuing new shares. 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 Shirai Electronics Industrial's EPS by clicking here.

How Is Dilution Impacting Shirai Electronics Industrial's Earnings Per Share (EPS)?

Shirai Electronics Industrial was losing money three years ago. Even looking at the last year, profit was still down 28%. Like a sack of potatoes thrown from a delivery truck, EPS fell harder, down 29% in the same period. Therefore, the dilution is having a noteworthy influence on shareholder returns.

If Shirai Electronics Industrial's EPS can grow over time then that drastically improves the chances of the share price moving in the same direction. 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 Shirai Electronics Industrial's Profit Performance

In conclusion, Shirai Electronics Industrial has a strong cashflow relative to earnings, which indicates good quality earnings, but the dilution means its earnings per share are dropping faster than its profit. Based on these factors, it's hard to tell if Shirai Electronics Industrial's profits are a reasonable reflection of its underlying profitability. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. In terms of investment risks, we've identified 4 warning signs with Shirai Electronics Industrial, and understanding them should be part of your investment process.

Our examination of Shirai Electronics Industrial has focussed on certain factors that can make its earnings look better than they are. 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. 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.