Here's Why NeoGames' (NASDAQ:NGMS) Statutory Earnings Are Arguably Too Conservative

It might be old fashioned, but we really like to invest in companies that make a profit, each and every year. 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 NeoGames (NASDAQ:NGMS).

It's good to see that over the last twelve months NeoGames made a profit of US$3.37m on revenue of US$44.2m.

Check out our latest analysis for NeoGames

Of course, it is only sensible to look beyond the statutory profits and question how well those numbers represent the sustainable earnings power of the business. As a result, we think it's well worth considering what NeoGames' cashflow (when compared to its earnings) can tell us about the nature of its statutory profit. 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.

Examining Cashflow Against NeoGames' 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. The accrual ratio subtracts the FCF from the profit for a given period, and divides the result by the average operating assets of the company over that time. 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. That is not intended to imply we should worry about a positive accrual ratio, but it's worth noting where the accrual ratio is rather high. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

NeoGames has an accrual ratio of -0.26 for the year to September 2020. Therefore, its statutory earnings were very significantly less than its free cashflow. Indeed, in the last twelve months it reported free cash flow of US$8.7m, well over the US$3.37m it reported in profit. NeoGames shareholders are no doubt pleased that free cash flow improved over the last twelve months.

Our Take On NeoGames' Profit Performance

Happily for shareholders, NeoGames produced plenty of free cash flow to back up its statutory profit numbers. Based on this observation, we consider it possible that NeoGames' statutory profit actually understates its earnings potential! And it's also positive that the company showed enough improvement to book a profit this year, after losing money last year. 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. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. For example, we've found that NeoGames has 2 warning signs (1 is significant!) that deserve your attention before going any further with your analysis.

This note has only looked at a single factor that sheds light on the nature of NeoGames' profit. But there are plenty of other ways to inform your opinion of a company. Some people consider a high return on equity to be a good sign of a quality business. 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. 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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