We Think You Can Look Beyond Paradox Interactive's (STO:PDX) Lackluster Earnings

The market for Paradox Interactive AB (publ)'s (STO:PDX) shares didn't move much after it posted weak earnings recently. We did some digging, and we believe the earnings are stronger than they seem.

View our latest analysis for Paradox Interactive

A Closer Look At Paradox Interactive'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. 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. This ratio tells us how much of a company's profit is not backed by free cashflow.

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. 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 December 2023, Paradox Interactive had an accrual ratio of -0.15. That indicates that its free cash flow quite significantly exceeded its statutory profit. In fact, it had free cash flow of kr746m in the last year, which was a lot more than its statutory profit of kr530.6m. Paradox Interactive's free cash flow improved over the last year, which is generally good to see. However, that's not all there is to consider. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio.

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.

The Impact Of Unusual Items On Profit

Paradox Interactive's profit was reduced by unusual items worth kr185m in the last twelve months, and this helped it produce high cash conversion, as reflected by its unusual items. This is what you'd expect to see where a company has a non-cash charge reducing paper profits. It's never great to see unusual items costing the company profits, but on the upside, things might improve sooner rather than later. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And, after all, that's exactly what the accounting terminology implies. If Paradox Interactive doesn't see those unusual expenses repeat, then all else being equal we'd expect its profit to increase over the coming year.

Our Take On Paradox Interactive's Profit Performance

In conclusion, both Paradox Interactive's accrual ratio and its unusual items suggest that its statutory earnings are probably reasonably conservative. Looking at all these factors, we'd say that Paradox Interactive's underlying earnings power is at least as good as the statutory numbers would make it seem. If you'd like to know more about Paradox Interactive as a business, it's important to be aware of any risks it's facing. For example - Paradox Interactive has 2 warning signs we think you should be aware of.

Our examination of Paradox Interactive has focussed on certain factors that can make its earnings look better than they are. And it has passed with flying colours. 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 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.