The market was pleased with the recent earnings report from Gentrack Group Limited (NZSE:GTK), despite the profit numbers being soft. We think that investors might be looking at some positive factors beyond the earnings numbers.

View our latest analysis for Gentrack Group

Examining Cashflow Against Gentrack 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). 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. This ratio tells us how much of a company's profit is not backed by free cashflow.

That means a negative accrual ratio is a good thing, because it shows that the company is bringing in more free cash flow than its profit would suggest. 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Gentrack Group has an accrual ratio of -0.17 for the year to September 2024. That indicates that its free cash flow quite significantly exceeded its statutory profit. In fact, it had free cash flow of NZ$33m in the last year, which was a lot more than its statutory profit of NZ$9.55m. Gentrack 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 Gentrack Group's Profit Performance

As we discussed above, Gentrack 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 Gentrack Group's underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! Unfortunately, though, its earnings per share actually fell back over the last year. 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. If you want to do dive deeper into Gentrack Group, you'd also look into what risks it is currently facing. You'd be interested to know, that we found 2 warning signs for Gentrack Group and you'll want to know about these bad boys.

Today we've zoomed in on a single data point to better understand the nature of Gentrack Group'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.