We Think Imperial Ginseng Products' (CVE:IGP) Robust Earnings Are Conservative

Despite announcing strong earnings, Imperial Ginseng Products Ltd.'s (CVE:IGP) stock was sluggish. We think that the market might be paying attention to some underlying factors are concerning.

See our latest analysis for Imperial Ginseng Products

Zooming In On Imperial Ginseng Products' 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. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. The ratio shows us how much a company's profit exceeds its FCF.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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".

Over the twelve months to September 2021, Imperial Ginseng Products recorded an accrual ratio of -0.45. That indicates that its free cash flow quite significantly exceeded its statutory profit. To wit, it produced free cash flow of CA$5.3m during the period, dwarfing its reported profit of CA$1.33m. Imperial Ginseng Products' free cash flow improved over the last year, which is generally good to see. Having said that, there is more to the story. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Imperial Ginseng Products.

The Impact Of Unusual Items On Profit

Surprisingly, given Imperial Ginseng Products' accrual ratio implied strong cash conversion, its paper profit was actually boosted by CA$3.2m in unusual items. While we like to see profit increases, we tend to be a little more cautious when unusual items have made a big contribution. When we crunched the numbers on thousands of publicly listed companies, we found that a boost from unusual items in a given year is often not repeated the next year. And that's as you'd expect, given these boosts are described as 'unusual'. We can see that Imperial Ginseng Products' positive unusual items were quite significant relative to its profit in the year to September 2021. As a result, we can surmise that the unusual items are making its statutory profit significantly stronger than it would otherwise be.

Our Take On Imperial Ginseng Products' Profit Performance

In conclusion, Imperial Ginseng Products' accrual ratio suggests its statutory earnings are of good quality, but on the other hand the profits were boosted by unusual items. Given the contrasting considerations, we don't have a strong view as to whether Imperial Ginseng Products's profits are an apt reflection of its underlying potential for profit. If you'd like to know more about Imperial Ginseng Products as a business, it's important to be aware of any risks it's facing. Case in point: We've spotted 4 warning signs for Imperial Ginseng Products you should be mindful of and 3 of them don't sit too well with us.

In this article we've looked at a number of factors that can impair the utility of profit numbers, as a guide to a business. But there are plenty of other ways to inform your opinion of a company. For example, many people consider a high return on equity as an indication of favorable business economics, while others like to 'follow the money' and search out stocks that insiders are buying. 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.