Investors Can Find Comfort In River Tech's (OB:RIVER) Earnings Quality

Investors were disappointed with the weak earnings posted by River Tech p.l.c. (OB:RIVER ). However, our analysis suggests that the soft headline numbers are getting counterbalanced by some positive underlying factors.

We've discovered 2 warning signs about River Tech. View them for free.

Zooming In On River Tech'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. 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

For the year to December 2024, River Tech had an accrual ratio of -0.29. That indicates that its free cash flow quite significantly exceeded its statutory profit. To wit, it produced free cash flow of €8.4m during the period, dwarfing its reported profit of €6.37m. River Tech's free cash flow improved over the last year, which is generally good to see.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of River Tech.

Our Take On River Tech's Profit Performance

As we discussed above, River Tech's accrual ratio indicates strong conversion of profit to free cash flow, which is a positive for the company. Because of this, we think River Tech's underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! And the EPS is up 33% annually, over the last three years. 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 while earnings quality is important, it's equally important to consider the risks facing River Tech at this point in time. In terms of investment risks, we've identified 2 warning signs with River Tech, and understanding these should be part of your investment process.

Today we've zoomed in on a single data point to better understand the nature of River Tech's profit. 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. 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.