As a general rule, we think profitable companies are less risky than companies that lose money. However, sometimes companies receive a one-off boost (or reduction) to their profit, and it’s not always clear whether statutory profits are a good guide, going forward. In this article, we’ll look at how useful this year’s statutory profit is, when analysing Atari (EPA:ATA).
While Atari was able to generate revenue of €24.0m in the last twelve months, we think its profit result of €2.30m was more important. While it managed to grow its revenue over the last three years, its profit has moved in the other direction, as you can see in the chart below.
Of course, when it comes to statutory profit, the devil is often in the detail, and we can get a better sense for a company by diving deeper into the financial statements. Therefore, today we’ll take a look at Atari’s cashflow, share issues and unusual items with a view to better understanding the nature of its statutory earnings. 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.
Zooming In On Atari’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. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company’s average operating assets over that period. This ratio tells us how much of a company’s profit is not backed by free cashflow.
As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. While having an accrual ratio above zero is of little concern, we do think it’s worth noting when a company has a relatively high accrual ratio. To quote a 2014 paper by Lewellen and Resutek, “firms with higher accruals tend to be less profitable in the future”.
Over the twelve months to March 2020, Atari recorded an accrual ratio of 0.51. As a general rule, that bodes poorly for future profitability. To wit, the company did not generate one whit of free cashflow in that time. In the last twelve months it actually had negative free cash flow, with an outflow of €8.5m despite its profit of €2.30m, mentioned above. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of €8.5m, this year, indicates high risk. Having said that, there is more to consider. We can look at how unusual items in the profit and loss statement impacted its accrual ratio, as well as explore how dilution is impacting shareholders negatively.
To understand the value of a company’s earnings growth, it is imperative to consider any dilution of shareholders’ interests. Atari expanded the number of shares on issue by 5.5% over the last year. Therefore, each share now receives a smaller portion of profit. Per share metrics like EPS help us understand how much actual shareholders are benefitting from the company’s profits, while the net income level gives us a better view of the company’s absolute size. Check out Atari’s historical EPS growth by clicking on this link.
A Look At The Impact Of Atari’s Dilution on Its Earnings Per Share (EPS).
Atari’s net profit dropped by 70% per year over the last three years. And even focusing only on the last twelve months, we see profit is down 15%. Like a sack of potatoes thrown from a delivery truck, EPS fell harder, down 5.4% in the same period. So you can see that the dilution has had a bit of an impact on shareholders. Therefore, the dilution is having a noteworthy influence on shareholder returns. And so, you can see quite clearly that dilution is influencing shareholder earnings.
If Atari’s EPS can grow over time then that drastically improves the chances of the share price moving in the same direction. However, if its profit increases while its earnings per share stay flat (or even fall) then shareholders might not see much benefit. For that reason, you could say that EPS is more important that net income in the long run, assuming the goal is to assess whether a company’s share price might grow.
The Impact Of Unusual Items On Profit
Unfortunately (in the short term) Atari saw its profit reduced by unusual items worth €800.0k. If this was a non-cash charge, it would have made the accrual ratio better, if cashflow had stayed strong, so it’s not great to see in combination with an uninspiring accrual ratio. While deductions due to unusual items are disappointing in the first instance, there is a silver lining. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And, after all, that’s exactly what the accounting terminology implies. Assuming those unusual expenses don’t come up again, we’d therefore expect Atari to produce a higher profit next year, all else being equal.
Our Take On Atari’s Profit Performance
In conclusion, Atari’s accrual ratio suggests that its statutory earnings are not backed by cash flow; but the fact unusual items actually weighed on profit may create upside if those unusual items to not recur. On top of that, the dilution means that shareholders now own less of the company. After taking into account all the aforementioned observations we think that Atari’s profits probably give a generous impression of its sustainable level of profitability. If you’d like to know more about Atari as a business, it’s important to be aware of any risks it’s facing. To that end, you should learn about the 3 warning signs we’ve spotted with Atari (including 1 which is concerning).
In this article we’ve looked at a number of factors that can impair the utility of profit numbers, and we’ve come away cautious. 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. 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. 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.
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