Impressive Earnings May Not Tell The Whole Story For Gambero Rosso (BIT:GAMB)

Investors were disappointed with Gambero Rosso S.p.A.'s (BIT:GAMB) earnings, despite the strong profit numbers. We think that the market might be paying attention to some underlying factors are concerning.

Check out our latest analysis for Gambero Rosso

A Closer Look At Gambero Rosso's 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. 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.

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 it's not a problem to have a positive accrual ratio, indicating a certain level of non-cash profits, a high accrual ratio is arguably a bad thing, because it indicates paper profits are not matched by cash flow. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

For the year to June 2023, Gambero Rosso had an accrual ratio of 0.29. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, raising questions about how useful that profit figure really is. In the last twelve months it actually had negative free cash flow, with an outflow of €4.9m despite its profit of €1.68m, mentioned above. It's worth noting that Gambero Rosso generated positive FCF of €1.4m a year ago, so at least they've done it in the past. One positive for Gambero Rosso 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.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Gambero Rosso.

Our Take On Gambero Rosso's Profit Performance

Gambero Rosso didn't convert much of its profit to free cash flow in the last year, which some investors may consider rather suboptimal. Therefore, it seems possible to us that Gambero Rosso's true underlying earnings power is actually less than its statutory profit. But at least holders can take some solace from the 14% EPS growth in the last year. 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. So while earnings quality is important, it's equally important to consider the risks facing Gambero Rosso at this point in time. When we did our research, we found 4 warning signs for Gambero Rosso (3 shouldn't be ignored!) that we believe deserve your full attention.

Today we've zoomed in on a single data point to better understand the nature of Gambero Rosso'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. 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. 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.