The market was pleased with the recent earnings report from Megaport Limited (ASX:MP1), despite the profit numbers being soft. Our analysis suggests that investors may have noticed some promising signs beyond the statutory profit figures.

View our latest analysis for Megaport

A Closer Look At Megaport'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. While having an accrual ratio above zero is of little concern, we do think it's worth noting when a company has a relatively high accrual ratio. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Megaport has an accrual ratio of -0.26 for the year to December 2024. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. To wit, it produced free cash flow of AU$32m during the period, dwarfing its reported profit of AU$6.04m. Megaport'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 Megaport's Profit Performance

As we discussed above, Megaport's accrual ratio indicates strong conversion of profit to free cash flow, which is a positive for the company. Because of this, we think Megaport's underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! On the other hand, its EPS actually shrunk in the last twelve months. The goal of this article has been to assess how well we can rely on the statutory earnings to reflect the company's potential, but there is plenty more to consider. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. For example - Megaport has 1 warning sign we think you should be aware of.

Today we've zoomed in on a single data point to better understand the nature of Megaport's profit. But there is always more to discover if you are capable of focussing your mind on minutiae. 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.