We Wouldn't Rely On Glory Star New Media Group Holdings's (NASDAQ:GSMG) Statutory Earnings As A Guide

It might be old fashioned, but we really like to invest in companies that make a profit, each and every year. Having said that, sometimes statutory profit levels are not a good guide to ongoing profitability, because some short term one-off factor has impacted profit levels. Today we'll focus on whether this year's statutory profits are a good guide to understanding Glory Star New Media Group Holdings (NASDAQ:GSMG).

While Glory Star New Media Group Holdings was able to generate revenue of US$62.9m in the last twelve months, we think its profit result of US$27.6m was more important.

View our latest analysis for Glory Star New Media Group Holdings

Of course, when it comes to statutory profit, the devil is often in the detail, and we can get a better sense for a company by diving deeper into the financial statements. So today we'll look at what Glory Star New Media Group Holdings' 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 Glory Star New Media Group Holdings.

A Closer Look At Glory Star New Media Group Holdings' 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. 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 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".

Glory Star New Media Group Holdings has an accrual ratio of 0.35 for the year to June 2020. Unfortunately, that means its free cash flow was a lot less than its statutory profit, which makes us doubt the utility of profit as a guide. To wit, it produced free cash flow of US$5.2m during the period, falling well short of its reported profit of US$27.6m. Notably, Glory Star New Media Group Holdings had negative free cash flow last year, so the US$5.2m it produced this year was a welcome improvement.

Our Take On Glory Star New Media Group Holdings' Profit Performance

As we discussed above, we think Glory Star New Media Group Holdings' earnings were not supported by free cash flow, which might concern some investors. For this reason, we think that Glory Star New Media Group Holdings' statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. Sadly, its EPS was down over the last twelve months. 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. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. Our analysis shows 3 warning signs for Glory Star New Media Group Holdings (2 make us uncomfortable!) and we strongly recommend you look at them before investing.

This note has only looked at a single factor that sheds light on the nature of Glory Star New Media Group Holdings' 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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