Should You Rely On Rovio Entertainment Oyj's (HEL:ROVIO) Earnings Growth?

Broadly speaking, profitable businesses are less risky than unprofitable ones. That said, the current statutory profit is not always a good guide to a company's underlying profitability. In this article, we'll look at how useful this year's statutory profit is, when analysing Rovio Entertainment Oyj (HEL:ROVIO).

We like the fact that Rovio Entertainment Oyj made a profit of €28.5m on its revenue of €275.4m, in the last year. The chart below shows how profit has actually increased over the last three years, even while revenue has declined.

View our latest analysis for Rovio Entertainment Oyj

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. So today we'll look at what Rovio Entertainment Oyj's cashflow tells us about the quality of its 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.

Examining Cashflow Against Rovio Entertainment Oyj's Earnings

In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). 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.

Therefore, it's actually considered a good thing when a company has a negative accrual ratio, but a bad thing if its accrual ratio is positive. 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.

Rovio Entertainment Oyj has an accrual ratio of -0.40 for the year to September 2020. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. To wit, it produced free cash flow of €45m during the period, dwarfing its reported profit of €28.5m. Rovio Entertainment Oyj shareholders are no doubt pleased that free cash flow improved over the last twelve months.

Our Take On Rovio Entertainment Oyj's Profit Performance

As we discussed above, Rovio Entertainment Oyj's accrual ratio indicates strong conversion of profit to free cash flow, which is a positive for the company. Because of this, we think Rovio Entertainment Oyj's underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! And on top of that, its earnings per share have grown at an extremely impressive rate over the last three years. 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. In light of this, if you'd like to do more analysis on the company, it's vital to be informed of the risks involved. While conducting our analysis, we found that Rovio Entertainment Oyj has 1 warning sign and it would be unwise to ignore it.

This note has only looked at a single factor that sheds light on the nature of Rovio Entertainment Oyj's profit. 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. 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 that insiders are buying to be useful.

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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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