Gulf Keystone Petroleum Limited (LON:GKP) just reported healthy earnings but the stock price didn't move much. We think that investors have missed some encouraging factors underlying the profit figures.

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Examining Cashflow Against Gulf Keystone Petroleum's Earnings

Many investors haven't heard of the accrual ratio from cashflow, but it is actually a useful measure of how well a company's profit is backed up by free cash flow (FCF) during a given period. 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. 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Over the twelve months to December 2024, Gulf Keystone Petroleum recorded an accrual ratio of -0.13. 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$66m in the last year, which was a lot more than its statutory profit of US$7.16m. Given that Gulf Keystone Petroleum had negative free cash flow in the prior corresponding period, the trailing twelve month resul of US$66m would seem to be a step in the right direction.

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 Gulf Keystone Petroleum's Profit Performance

As we discussed above, Gulf Keystone Petroleum has perfectly satisfactory free cash flow relative to profit. Based on this observation, we consider it likely that Gulf Keystone Petroleum's statutory profit actually understates its earnings potential! And it's also positive that the company showed enough improvement to book a profit this year, after losing money last year. 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 Gulf Keystone Petroleum at this point in time. For example - Gulf Keystone Petroleum has 1 warning sign we think you should be aware of.

This note has only looked at a single factor that sheds light on the nature of Gulf Keystone Petroleum's profit. But there are plenty of other ways to inform your opinion of a company. Some people consider a high return on equity to be a good sign of a quality business. 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.