The Strong Earnings Posted By Agora (WSE:AGO) Are A Good Indication Of The Strength Of The Business

Agora S.A.'s (WSE:AGO) strong earnings report was rewarded with a positive stock price move. We did some digging and found some further encouraging factors that investors will like.

Check out our latest analysis for Agora

A Closer Look At Agora'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. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. This ratio tells us how much of a company's profit is not backed by free cashflow.

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. 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 March 2024, Agora recorded an accrual ratio of -0.22. That indicates that its free cash flow quite significantly exceeded its statutory profit. To wit, it produced free cash flow of zł212m during the period, dwarfing its reported profit of zł32.2m. Agora's free cash flow improved over the last year, which is generally good to see. Having said that, there is more to the story. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part.

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

How Do Unusual Items Influence Profit?

Agora's profit was reduced by unusual items worth zł11m in the last twelve months, and this helped it produce high cash conversion, as reflected by its unusual items. In a scenario where those unusual items included non-cash charges, we'd expect to see a strong accrual ratio, which is exactly what has happened in this case. While deductions due to unusual items are disappointing in the first instance, there is a silver lining. We looked at thousands of listed companies and found that unusual items are very often one-off in nature. And that's hardly a surprise given these line items are considered unusual. If Agora doesn't see those unusual expenses repeat, then all else being equal we'd expect its profit to increase over the coming year.

Our Take On Agora's Profit Performance

In conclusion, both Agora's accrual ratio and its unusual items suggest that its statutory earnings are probably reasonably conservative. Based on these factors, we think Agora's underlying earnings potential is as good as, or probably even better, than the statutory profit makes it seem! Just as investors must consider earnings, it is also important to take into account the strength of a company's balance sheet. We've done some analysis and you can see our take on Agora's balance sheet by clicking here.

Our examination of Agora has focussed on certain factors that can make its earnings look better than they are. And it has passed with flying colours. 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 with high insider ownership.

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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.