Investors were disappointed with the weak earnings posted by ICO Group Limited (HKG:1460 ). Despite the soft profit numbers, our analysis has optimistic about the overall quality of the income statement.

Check out our latest analysis for ICO Group

Zooming In On ICO Group's Earnings

Many investors haven't heard of the accrual ratio from cashflow, but it is actually a useful measure of how well a company's profit is backed up by free cash flow (FCF) during a given period. 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.

ICO Group has an accrual ratio of -0.20 for the year to September 2023. That indicates that its free cash flow quite significantly exceeded its statutory profit. In fact, it had free cash flow of HK$93m in the last year, which was a lot more than its statutory profit of HK$10.1m. ICO Group shareholders are no doubt pleased that free cash flow improved over the last twelve months. Having said that, there is more to the story. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of ICO Group.

The Impact Of Unusual Items On Profit

ICO Group's profit was reduced by unusual items worth HK$21m in the last twelve months, and this helped it produce high cash conversion, as reflected by its unusual items. This is what you'd expect to see where a company has a non-cash charge reducing paper profits. It's never great to see unusual items costing the company profits, but on the upside, things might improve sooner rather than later. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And, after all, that's exactly what the accounting terminology implies. In the twelve months to September 2023, ICO Group had a big unusual items expense. As a result, we can surmise that the unusual items made its statutory profit significantly weaker than it would otherwise be.

Our Take On ICO Group's Profit Performance

In conclusion, both ICO Group's accrual ratio and its unusual items suggest that its statutory earnings are probably reasonably conservative. Based on these factors, we think ICO Group's underlying earnings potential is as good as, or probably even better, than the statutory profit makes it seem! Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. For example, ICO Group has 4 warning signs (and 1 which can't be ignored) we think you should know about.

After our examination into the nature of ICO Group's profit, we've come away optimistic for the company. 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 that insiders are buying.

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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.