Gaming Factory (WSE:GIF) Strong Profits May Be Masking Some Underlying Issues

The recent earnings posted by Gaming Factory S.A. (WSE:GIF) were solid, but the stock didn't move as much as we expected. We believe that shareholders have noticed some concerning factors beyond the statutory profit numbers.

View our latest analysis for Gaming Factory

A Closer Look At Gaming Factory'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). 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

For the year to December 2020, Gaming Factory had an accrual ratio of 0.40. As a general rule, that bodes poorly for future profitability. To wit, the company did not generate one whit of free cashflow in that time. Even though it reported a profit of zł5.93m, a look at free cash flow indicates it actually burnt through zł1.5m in the last year. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of zł1.5m, this year, indicates high risk.

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

Our Take On Gaming Factory's Profit Performance

As we discussed above, we think Gaming Factory'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 Gaming Factory's underlying earnings power is lower than its statutory profit. But at least holders can take some solace from the 47% per annum growth in EPS for the last three. 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. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. For instance, we've identified 5 warning signs for Gaming Factory (2 are a bit concerning) you should be familiar with.

Today we've zoomed in on a single data point to better understand the nature of Gaming Factory'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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