Should You Rely On Ultimate Games's (WSE:ULG) Earnings Growth?

Broadly speaking, profitable businesses are less risky than unprofitable ones. That said, the current statutory profit is not always a good guide to a company's underlying profitability. Today we'll focus on whether this year's statutory profits are a good guide to understanding Ultimate Games (WSE:ULG).

We like the fact that Ultimate Games made a profit of zł7.90m on its revenue of zł13.3m, in the last year. In the chart below, you can see that its profit and revenue have both grown over the last three years.

View our latest analysis for Ultimate Games

Importantly, statutory profits are not always the best tool for understanding a company's true earnings power, so it's well worth examining profits in a little more detail. So today we'll look at what Ultimate Games' cashflow tells us about the quality of its earnings. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Ultimate Games.

Zooming In On Ultimate Games' Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. While having an accrual ratio above zero is of little concern, we do think it's worth noting when a company has a relatively high accrual ratio. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Over the twelve months to September 2020, Ultimate Games recorded an accrual ratio of 1.81. Ergo, its free cash flow is significantly weaker than its profit. Statistically speaking, that's a real negative for future earnings. In fact, it had free cash flow of zł2.5m in the last year, which was a lot less than its statutory profit of zł7.90m. We note, however, that Ultimate Games grew its free cash flow over the last year.

Our Take On Ultimate Games' Profit Performance

As we have made quite clear, we're a bit worried that Ultimate Games didn't back up the last year's profit with free cashflow. For this reason, we think that Ultimate Games' statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. The silver lining is that its EPS growth over the last year has been really wonderful, even if it's not a perfect measure. The goal of this article has been to assess how well we can rely on the statutory earnings to reflect the company's potential, but there is plenty more to consider. If you'd like to know more about Ultimate Games as a business, it's important to be aware of any risks it's facing. Case in point: We've spotted 3 warning signs for Ultimate Games you should be mindful of and 1 of these is a bit concerning.

This note has only looked at a single factor that sheds light on the nature of Ultimate Games' profit. But there is always more to discover if you are capable of focussing your mind on minutiae. Some people consider a high return on equity to be a good sign of a quality business. 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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