When it comes to the FTSE 100, most investors gravitate towards familiar names like Shell, HSBC or Unilever. But among the lesser-covered stocks, one company stands out: 3i Group (LSE: III), the private equity giant that’s become one of the most profitable stocks on the index.

Revenue’s up 53% in the past year and its diluted earnings growth is up to 31% year on year. Even more eye-catching, its share price has climbed an astonishing 380% over the past five years. It’s no surprise many are wondering how this FTSE 100 company is delivering such remarkable financial results, and what’s driving the growth.

Where does the money come from?

Rather than sell products or services, 3i makes its money by investing in businesses around the world. With the addition of some infrastructure assets, it focuses heavily on private equity, most notably the European discount retailer Action.

This is the key reason why its accounts look so unusual. In the latest period, it reported a net margin of a staggering 297%, driven almost entirely by unrealised valuation gains. In other words, its reported profits are primarily accounting increases in the estimated value of companies it owns, rather than cash generated by selling goods or services.

The same effect explains why its price-to-earnings (P/E) ratio sits at just 7.92, despite its share price soaring. On the face of it, that looks like a bargain valuation for such strong growth. But the reality’s a little more complicated.

The catch: profits built on portfolio valuations

This is where the risk comes in. Because 3i’s earnings rely on marking up the value of its portfolio, a change in market conditions could quickly swing profits into losses. In fact, running a simple scenario analysis shows just how sensitive its results are.

In a strong year (like 2024), a 20% rise in asset values can create billions in paper profits. In a flat year, with no change in valuations, 3i’s earnings could drop to only a few hundred million, driven by dividends and fees.

In a mild downturn, with a 10% fall in valuations, it could post accounting losses of around £2bn — despite the underlying companies still operating well.

The good news is that the firm’s balance sheet looks solid, with a low debt-to-equity ratio of just 0.05. That reduces the likelihood of any serious problems if earnings dip. Plus, it enjoys strong free cash flow from top earners like Action, which continues to grow rapidly, supporting operations and dividend coverage.

Should investors consider it?

For now, many long-term shareholders seem comfortable with this model. After all, 3i’s proven remarkably skilled at picking winners, compounding its net asset value over decades. Still, it’s important to recognise the unique risks that come with investing in a private equity-focused business.

For me, 3i remains one of the most intriguing stocks on the FTSE 100. Like any major company, it’s audited and follows strict accounting standards, so the impressive growth is genuine. However, it also relies heavily on the continued rise in the value of its private investments. That means this could be a spectacular long-term compounder — or a bumpy ride if markets turn. 

Either way, I think it’s a stock worth considering — particularly for more risk-averse investors seeking exposure to the private equity sector.