Should You Rely On Zengame Technology Holding's (HKG:2660) Earnings Growth?

Many investors consider it preferable to invest in profitable companies over unprofitable ones, because profitability suggests a business is sustainable. 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. Today we'll focus on whether this year's statutory profits are a good guide to understanding Zengame Technology Holding (HKG:2660).

We like the fact that Zengame Technology Holding made a profit of CN¥222.1m on its revenue of CN¥822.5m, in the last year. Happily, it has grown both its profit and revenue over the last three years, as you can see in the chart below.

See our latest analysis for Zengame Technology Holding

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. Today, we'll discuss Zengame Technology Holding's free cashflow relative to its earnings, and consider what that tells us about the company. 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 Zengame Technology Holding'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. 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. The ratio shows us how much a company's profit exceeds its FCF.

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. 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 June 2020, Zengame Technology Holding had an accrual ratio of 0.53. That means it didn't generate anywhere near enough free cash flow to match its profit. Statistically speaking, that's a real negative for future earnings. Indeed, in the last twelve months it reported free cash flow of CN¥172m, which is significantly less than its profit of CN¥222.1m. At this point we should mention that Zengame Technology Holding did manage to increase its free cash flow in the last twelve months

Our Take On Zengame Technology Holding's Profit Performance

As we discussed above, we think Zengame Technology Holding's 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 Zengame Technology Holding's underlying earnings power is lower than its statutory profit. The good news is that, its earnings per share increased by 46% in the last year. 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. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. While conducting our analysis, we found that Zengame Technology Holding has 1 warning sign and it would be unwise to ignore it.

Today we've zoomed in on a single data point to better understand the nature of Zengame Technology Holding'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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