We Think That There Are Issues Underlying GME Group Holdings' (HKG:8188) Earnings

Last week's profit announcement from GME Group Holdings Limited (HKG:8188) was underwhelming for investors, despite headline numbers being robust. Our analysis uncovered some concerning factors that we believe the market might be paying attention to.

View our latest analysis for GME Group Holdings

A Closer Look At GME Group Holdings' 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. To get the accrual ratio we first subtract FCF from profit for a period, and then divide that number by the average operating assets for the 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. 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.

For the year to December 2023, GME Group Holdings had an accrual ratio of 0.55. As a general rule, that bodes poorly for future profitability. And indeed, during the period the company didn't produce any free cash flow whatsoever. Even though it reported a profit of HK$61.5m, a look at free cash flow indicates it actually burnt through HK$24m in the last year. We also note that GME Group Holdings' free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of HK$24m.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of GME Group Holdings.

Our Take On GME Group Holdings' Profit Performance

As we discussed above, we think GME Group Holdings' earnings were not supported by free cash flow, which might concern some investors. As a result, we think it may well be the case that GME Group Holdings' underlying earnings power is lower than its statutory profit. But the good news is that its EPS growth over the last three years has been very impressive. At the end of the day, it's essential to consider more than just the factors above, if you want to understand the company properly. If you'd like to know more about GME Group Holdings as a business, it's important to be aware of any risks it's facing. For instance, we've identified 5 warning signs for GME Group Holdings (3 make us uncomfortable) you should be familiar with.

Today we've zoomed in on a single data point to better understand the nature of GME Group Holdings' 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. 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. 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.