Avi-Tech Holdings Limited (SGX:1R6) just reported healthy earnings but the stock price didn't move much. Our analysis suggests that investors might be missing some promising details.

Examining Cashflow Against Avi-Tech Holdings' 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. The ratio shows us how much a company's profit exceeds its FCF.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. While it's not a problem to have a positive accrual ratio, indicating a certain level of non-cash profits, a high accrual ratio is arguably a bad thing, because it indicates paper profits are not matched by cash flow. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Avi-Tech Holdings has an accrual ratio of -0.20 for the year to December 2023. That indicates that its free cash flow quite significantly exceeded its statutory profit. In fact, it had free cash flow of S$7.6m in the last year, which was a lot more than its statutory profit of S$4.08m. Avi-Tech Holdings shareholders are no doubt pleased that free cash flow improved over the last twelve months.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Avi-Tech Holdings.

Our Take On Avi-Tech Holdings' Profit Performance

As we discussed above, Avi-Tech Holdings' accrual ratio indicates strong conversion of profit to free cash flow, which is a positive for the company. Based on this observation, we consider it possible that Avi-Tech Holdings' statutory profit actually understates its earnings potential! And on top of that, its earnings per share increased by 27% in the last year. Of course, we've only just scratched the surface when it comes to analysing its earnings; one could also consider margins, forecast growth, and return on investment, among other factors. So while earnings quality is important, it's equally important to consider the risks facing Avi-Tech Holdings at this point in time. To help with this, we've discovered 3 warning signs (1 is concerning!) that you ought to be aware of before buying any shares in Avi-Tech Holdings.

This note has only looked at a single factor that sheds light on the nature of Avi-Tech Holdings' profit. 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 that insiders are buying 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.