The Strong Earnings Posted By VAALCO Energy (NYSE:EGY) Are A Good Indication Of The Strength Of The Business

The subdued stock price reaction suggests that VAALCO Energy, Inc.'s (NYSE:EGY) strong earnings didn't offer any surprises. We think that investors have missed some encouraging factors underlying the profit figures.

View our latest analysis for VAALCO Energy

Zooming In On VAALCO Energy'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). 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'.

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".

For the year to March 2024, VAALCO Energy had an accrual ratio of -0.14. That indicates that its free cash flow was a fair bit more than its statutory profit. In fact, it had free cash flow of US$117m in the last year, which was a lot more than its statutory profit of US$64.0m. VAALCO Energy's free cash flow improved over the last year, which is generally good to see.

That might leave you wondering what analysts are forecasting in terms of future profitability. Luckily, you can click here to see an interactive graph depicting future profitability, based on their estimates.

Our Take On VAALCO Energy's Profit Performance

VAALCO Energy's accrual ratio is solid, and indicates strong free cash flow, as we discussed, above. Based on this observation, we consider it likely that VAALCO Energy's statutory profit actually understates its earnings potential! Better yet, its EPS are growing strongly, which is nice to see. Of course, we've only just scratched the surface when it comes to analysing its earnings; one could also consider margins, forecast growth, and return on investment, among other factors. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. While conducting our analysis, we found that VAALCO Energy has 1 warning sign and it would be unwise to ignore it.

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