The (TSE:3076) was strong after the company recently reported robust earnings. We’ve done some analysis and believe investors are missing some details hidden behind the earnings numbers.
Check out our latest analysis for Ai Holdings
Zoom in on Ai Holdings earnings
An important financial metric that measures how well a company converts its profit into free cash flow (FCF) is the Delimitation ratio. To get the accrual ratio, we first subtract FCF from profit for a period and then divide that number by average funds from operations for the period. This ratio indicates how much of a company’s profit is not covered by free cash flow.
Therefore, it is actually considered good if a company has a negative accrual ratio, but bad if its accrual ratio is positive. While it is not a problem to have a positive accrual ratio, indicating some level of non-cash profits, a high accrual ratio is arguably a bad thing because it indicates that there is no cash flow to match accounting profits. To quote a 2014 paper by Lewellen and Resutek, “Companies with higher accruals tend to be less profitable in the future.”
For the year to June 2024, Ai Holdings had an accrual ratio of 0.26. Therefore, we know that its free cash flow was significantly lower than its statutory profit, which is hardly a good thing. In fact, it had free cash flow of JP¥6.2bn last year, which was much less than its statutory profit of JP¥15.7bn. However, we note that Ai Holdings grew its free cash flow last year. That’s not all there is to consider, however. The accrual ratio reflects, at least in part, the impact of unusual items on statutory profit.
You may be wondering what analysts are predicting in terms of future profitability. Fortunately, you can click here to see an interactive chart depicting future profitability based on their estimates.
The impact of unusual items on profit
Unfortunately (in the short term), Ai Holdings’ earnings were reduced by JP¥1.3 billion worth of unusual items. If it had been a non-cash charge, it would have been easier to achieve high cash conversion, so it’s surprising that the provision ratio tells a different story. While deductions due to unusual items are disappointing to begin with, there is one silver lining. We’ve looked at thousands of publicly traded companies and found that unusual items are very often one-off in nature. And that’s hardly surprising, given that these items are considered unusual. Unless these unusual expenses repeat at Ai Holdings, all other things being equal, we’d expect earnings to grow in the coming year.
Our assessment of Ai Holdings’ earnings development
At Ai Holdings, unusual items weighed on earnings, which should have made it easier to report high cash conversion, but according to the accrual ratio, that wasn’t the case. Because of these factors, we think it’s very unlikely that Ai Holdings’ statutory earnings make the company look much weaker than it is. So if you want to dig deeper into this stock, it’s important to consider all the risks it faces. At Simply Wall St, we found 2 warning signs for Ai Holdings and we think they deserve your attention.
In this article, we’ve looked at a number of factors that can affect the usefulness of earnings numbers as a guide to a company. But there are many other ways to form an opinion about a company. Some people consider a high return on equity to be a good sign of a high-quality company, so you might want to look at this. free Collection of companies with high return on equity or this list of stocks with high insider ownership.
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This Simply Wall St article is of a general nature. We comment solely on the basis of historical data and analyst forecasts, using an unbiased methodology. Our articles do not constitute financial advice. It is not a recommendation to buy or sell any stock and does not take into account your objectives or financial situation. Our goal is to provide you with long-term analysis based on fundamental data. Note that our analysis may not take into account the latest price-sensitive company announcements or qualitative materials. Simply Wall St does not hold any of the stocks mentioned.
