Adtraction Group's (STO:ADTR) Conservative Accounting Might Explain Soft Earnings

Investors were disappointed with the weak earnings posted by Adtraction Group AB (STO:ADTR ). While the headline numbers were soft, we believe that investors might be missing some encouraging factors.

See our latest analysis for Adtraction Group

A Closer Look At Adtraction Group'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. The accrual ratio subtracts the FCF from the profit for a given period, and divides the result by the average operating assets of the company over that time. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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. 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".

For the year to June 2022, Adtraction Group had an accrual ratio of -1.17. That indicates that its free cash flow quite significantly exceeded its statutory profit. In fact, it had free cash flow of kr43m in the last year, which was a lot more than its statutory profit of kr14.9m. Adtraction Group'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 Adtraction Group.

Our Take On Adtraction Group's Profit Performance

As we discussed above, Adtraction Group's accrual ratio indicates strong conversion of profit to free cash flow, which is a positive for the company. Based on this observation, we consider it possible that Adtraction Group's statutory profit actually understates its earnings potential! 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 Adtraction Group, you'd also look into what risks it is currently facing. At Simply Wall St, we found 2 warning signs for Adtraction Group and we think they deserve your attention.

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