VCI Global Limited's (NASDAQ:VCIG ) stock didn't jump after it announced some healthy earnings. We think that investors might be worried about some concerning underlying factors.
Zooming In On VCI Global's Earnings
One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. 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. 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".
VCI Global has an accrual ratio of 0.59 for the year to December 2023. That means it didn't generate anywhere near enough free cash flow to match its profit. Statistically speaking, that's a real negative for future earnings. To wit, it produced free cash flow of RM3.2m during the period, falling well short of its reported profit of RM35.7m. Notably, VCI Global had negative free cash flow last year, so the RM3.2m it produced this year was a welcome improvement.
Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of VCI Global.
Our Take On VCI Global's Profit Performance
As we have made quite clear, we're a bit worried that VCI Global didn't back up the last year's profit with free cashflow. For this reason, we think that VCI Global's statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. But the good news is that its EPS growth over the last three years has been very impressive. 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. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. Every company has risks, and we've spotted 6 warning signs for VCI Global (of which 1 is a bit unpleasant!) you should know about.
Today we've zoomed in on a single data point to better understand the nature of VCI Global'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. 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.