The subdued stock price reaction suggests that ICO Group Limited's (HKG:1460) strong earnings didn't offer any surprises. Investors are probably missing some underlying factors which are encouraging for the future of the company.

Zooming In On ICO Group's 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. 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. This ratio tells us how much of a company's profit is not backed by free cashflow.

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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Over the twelve months to March 2024, ICO Group recorded an accrual ratio of -0.22. Therefore, its statutory earnings were very significantly less than its free cashflow. Indeed, in the last twelve months it reported free cash flow of HK$94m, well over the HK$16.7m it reported in profit. ICO Group did see its free cash flow drop year on year, which is less than ideal, like a Simpson's episode without Groundskeeper Willie.

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

Our Take On ICO Group's Profit Performance

Happily for shareholders, ICO Group produced plenty of free cash flow to back up its statutory profit numbers. Based on this observation, we consider it possible that ICO Group's statutory profit actually understates its earnings potential! And on top of that, its earnings per share have grown at 58% per year over the last three years. At the end of the day, it's essential to consider more than just the factors above, if you want to understand the company properly. So while earnings quality is important, it's equally important to consider the risks facing ICO Group at this point in time. For example, ICO Group has 4 warning signs (and 2 which shouldn't be ignored) we think you should know about.

This note has only looked at a single factor that sheds light on the nature of ICO Group's 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. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com