Inghams Group Limited's (ASX:ING) stock was strong despite it releasing a soft earnings report last week. However, we think the company is showing some signs that things are more promising than they seem.

See our latest analysis for Inghams Group

Examining Cashflow Against Inghams Group's Earnings

In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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. 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.

Inghams Group has an accrual ratio of -0.28 for the year to December 2024. Therefore, its statutory earnings were very significantly less than its free cashflow. To wit, it produced free cash flow of AU$297m during the period, dwarfing its reported profit of AU$89.6m. Inghams Group's free cash flow improved over the last year, which is generally good to see.

That might leave you wondering what analysts are forecasting in terms of future profitability. Luckily, you can click here to see an interactive graph depicting future profitability, based on their estimates.

Our Take On Inghams Group's Profit Performance

As we discussed above, Inghams Group's accrual ratio indicates strong conversion of profit to free cash flow, which is a positive for the company. Because of this, we think Inghams Group's underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! And it's also good to see that its earnings per share have improved a bit 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 Inghams Group at this point in time. Every company has risks, and we've spotted 2 warning signs for Inghams Group (of which 1 can't be ignored!) you should know about.

Today we've zoomed in on a single data point to better understand the nature of Inghams 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. 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 with significant insider holdings 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.