The market rallied behind Guizhou RedStar Developing Co.,Ltd.'s (SHSE:600367) stock, leading do a rise in the share price after its recent weak earnings report. While shareholders may be willing to overlook soft profit numbers, we believe that they should also be taking into account some other factors which may be cause for concern.

One essential aspect of assessing earnings quality is to look at how much a company is diluting shareholders. In fact, Guizhou RedStar DevelopingLtd increased the number of shares on issue by 16% over the last twelve months by issuing new shares. As a result, its net income is now split between a greater number of shares. To talk about net income, without noticing earnings per share, is to be distracted by the big numbers while ignoring the smaller numbers that talk to per share value. You can see a chart of Guizhou RedStar DevelopingLtd's EPS by clicking here.

How Is Dilution Impacting Guizhou RedStar DevelopingLtd's Earnings Per Share (EPS)?

Unfortunately, Guizhou RedStar DevelopingLtd's profit is down 50% per year over three years. Even looking at the last year, profit was still down 67%. Like a sack of potatoes thrown from a delivery truck, EPS fell harder, down 66% in the same period. Therefore, the dilution is having a noteworthy influence on shareholder returns.

If Guizhou RedStar DevelopingLtd's EPS can grow over time then that drastically improves the chances of the share price moving in the same direction. But on the other hand, we'd be far less excited to learn profit (but not EPS) was improving. For the ordinary retail shareholder, EPS is a great measure to check your hypothetical "share" of the company's profit.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Guizhou RedStar DevelopingLtd.

How Do Unusual Items Influence Profit?

Finally, we should also consider the fact that unusual items boosted Guizhou RedStar DevelopingLtd's net profit by CN¥20m over the last year. While it's always nice to have higher profit, a large contribution from unusual items sometimes dampens our enthusiasm. 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. Assuming those unusual items don't show up again in the current year, we'd thus expect profit to be weaker next year (in the absence of business growth, that is).

Our Take On Guizhou RedStar DevelopingLtd's Profit Performance

In its last report Guizhou RedStar DevelopingLtd benefitted from unusual items which boosted its profit, which could make the profit seem better than it really is on a sustainable basis. On top of that, the dilution means that its earnings per share performance is worse than its profit performance. For the reasons mentioned above, we think that a perfunctory glance at Guizhou RedStar DevelopingLtd's statutory profits might make it look better than it really is on an underlying level. So while earnings quality is important, it's equally important to consider the risks facing Guizhou RedStar DevelopingLtd at this point in time. You'd be interested to know, that we found 4 warning signs for Guizhou RedStar DevelopingLtd and you'll want to know about these.

Our examination of Guizhou RedStar DevelopingLtd has focussed on certain factors that can make its earnings look better than they are. And, on that basis, we are somewhat skeptical. 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. 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. 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.