Mgame's (KOSDAQ:058630) Sluggish Earnings Might Be Just The Beginning Of Its Problems

Despite Mgame Corp.'s (KOSDAQ:058630) recent earnings report having lackluster headline numbers, the market responded positively. Sometimes, shareholders are willing to ignore soft numbers with the hope that they will improve, but our analysis suggests this is unlikely for Mgame.

Check out our latest analysis for Mgame

Examining Cashflow Against Mgame's Earnings

As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. The ratio shows us how much a company's profit exceeds its FCF.

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. 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 September 2024, Mgame had an accrual ratio of 0.32. 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. To wit, it produced free cash flow of ₩8.9b during the period, falling well short of its reported profit of ₩18.2b. Mgame shareholders will no doubt be hoping that its free cash flow bounces back next year, since it was down over the last twelve months. One positive for Mgame 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. As a result, some shareholders may be looking for stronger cash conversion in the current year.

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

Our Take On Mgame's Profit Performance

Mgame's accrual ratio for the last twelve months signifies cash conversion is less than ideal, which is a negative when it comes to our view of its earnings. Therefore, it seems possible to us that Mgame's true underlying earnings power is actually less than its statutory profit. But at least holders can take some solace from the 16% per annum growth in EPS for the last three. 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. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. Be aware that Mgame is showing 2 warning signs in our investment analysis and 1 of those is a bit concerning...

This note has only looked at a single factor that sheds light on the nature of Mgame'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 with significant insider holdings 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.