Costain Group PLC (LON:COST) recently announced strong results and the market rewarded this with a strong increase in the share price. Looking more closely at the numbers, we found several encouraging factors in addition to the earnings figures.

Check out our latest analysis for Costain Group

Costain Group’s profits in detail

Many investors have never heard of the Accrual ratio from cash flowbut it is actually a useful measure of how well a company’s profit is covered by free cash flow (FCF) during a given period. The accrual ratio subtracts FCF from profit for a given period and divides the result by the company’s average funds from operations during that period. You could think of the accrual ratio from cash flow as the “non-FCF profit ratio.”

Consequently, a negative accrual ratio is positive for the company, and a positive accrual ratio is negative. While an accrual ratio above zero is hardly a cause for concern, we still think it is noteworthy when a company has a relatively high accrual ratio. To quote a 2014 paper by Lewellen and Resutek, “Companies with higher accruals tend to be less profitable in the future.”

For the twelve months to June 2024, Costain Group recorded an accrual ratio of -0.25. Therefore, its statutory profits were a lot less than its free cash flow. In fact, it had free cash flow of £48m last year, which was a lot more than its statutory profit of £30.5m. Costain Group actually saw its free cash flow decline year-on-year, which is far from ideal, like a Simpsons episode without Groundskeeper Willie. There’s more to the story, though. The accrual ratio reflects, at least in part, the impact of unusual items on statutory profit.

You may be wondering what analysts are predicting in terms of future profitability. Fortunately, you can click here to see an interactive chart depicting future profitability based on their estimates.

The impact of unusual items on profit

Costain Group’s profit was reduced by £8.3m worth of unusual items over the last twelve months, which contributed to high cash conversion, which is reflected in the unusual items. In a scenario where these unusual items included non-cash costs, we would expect a strong provisioning ratio, and that is exactly what happened in this case. While deductions due to unusual items are disappointing to begin with, there is one silver lining. When we analyzed the vast majority of listed companies globally, we found that significant unusual items are often non-recurring. And that is exactly what accounting terminology implies. If these unusual expenses are non-recurring at Costain Group, all other things being equal, we would expect its profit to grow in the coming year.

The story continues

Our assessment of the Costain Group’s earnings development

Given Costain Group’s accrual ratio and unusual items, we think it’s unlikely that its statutory profits overstate the company’s underlying earnings power. After taking all this into account, we believe Costain Group’s statutory profits probably understate its earnings potential! Of course, we like to look at historical data to form our opinion on a company. But it can be really valuable to consider other analysts’ forecasts. Luckily, you can see analyst forecasts here.

After examining the nature of Costain Group’s earnings, we are optimistic about the company. But there is always more to discover if you are able to focus on the details. For example, many people consider a high return on equity to be an indication of a favorable business situation, while others like to “follow the money” and look for stocks that insiders are buying. You might want to check this out. free Collection of companies with high return on equity or this list of stocks with high insider ownership.

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This Simply Wall St article is of a general nature. We comment solely on historical data and analyst forecasts, using an unbiased methodology. Our articles do not constitute financial advice. It is not a recommendation to buy or sell any stock and does not take into account your objectives or financial situation. Our goal is to provide you with long-term analysis based on fundamental data. Note that our analysis may not take into account the latest price-sensitive company announcements or qualitative materials. Simply Wall St does not hold any of the stocks mentioned.