Should You Rely On Remedy Entertainment Oyj's (HEL:REMEDY) Earnings Growth?

Statistically speaking, it is less risky to invest in profitable companies than in unprofitable ones. Having said that, sometimes statutory profit levels are not a good guide to ongoing profitability, because some short term one-off factor has impacted profit levels. This article will consider whether Remedy Entertainment Oyj's (HEL:REMEDY) statutory profits are a good guide to its underlying earnings.

It's good to see that over the last twelve months Remedy Entertainment Oyj made a profit of €6.57m on revenue of €37.9m. We know some investors love those high revenue growth stocks, but we do like to look at profit, even if it is, perhaps, a bit old fashioned. In the chart below, you can see that its profit and revenue have both grown over the last three years.

Check out our latest analysis for Remedy Entertainment Oyj

Of course, it is only sensible to look beyond the statutory profits and question how well those numbers represent the sustainable earnings power of the business. As a result, we think it's well worth considering what Remedy Entertainment Oyj's cashflow (when compared to its earnings) can tell us about the nature of its statutory profit. 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.

A Closer Look At Remedy Entertainment Oyj'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. 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. This ratio tells us how much of a company's profit is not backed by free cashflow.

That means a negative accrual ratio is a good thing, because it shows that the company is bringing in more free cash flow than its profit would suggest. 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 June 2020, Remedy Entertainment Oyj recorded an accrual ratio of 0.84. Statistically speaking, that's a real negative for future earnings. To wit, the company did not generate one whit of free cashflow in that time. Even though it reported a profit of €6.57m, a look at free cash flow indicates it actually burnt through €1.4m in the last year. We saw that FCF was €6.7m a year ago though, so Remedy Entertainment Oyj has at least been able to generate positive FCF in the past. One positive for Remedy Entertainment Oyj shareholders is that it's accrual ratio was significantly better last year, providing reason to believe that it may return to stronger cash conversion in the future. Shareholders should look for improved cashflow relative to profit in the current year, if that is indeed the case.

Our Take On Remedy Entertainment Oyj's Profit Performance

As we have made quite clear, we're a bit worried that Remedy Entertainment Oyj didn't back up the last year's profit with free cashflow. For this reason, we think that Remedy Entertainment Oyj's statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. But on the bright side, its earnings per share have grown at an extremely impressive rate over the last three years. 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. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. For example - Remedy Entertainment Oyj 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 Remedy Entertainment Oyj's profit. But there is always more to discover if you are capable of focussing your mind on minutiae. 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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