Following the solid earnings report from IKD Co., Ltd. (SHSE:600933), the market responded by bidding up the stock price. While the profit numbers were good, our analysis has found some concerning factors that shareholders should be aware of.

One essential aspect of assessing earnings quality is to look at how much a company is diluting shareholders. In fact, IKD increased the number of shares on issue by 9.1% over the last twelve months by issuing new shares. That means its earnings are split among 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. Check out IKD's historical EPS growth by clicking on this link.

How Is Dilution Impacting IKD's Earnings Per Share (EPS)?

As you can see above, IKD has been growing its net income over the last few years, with an annualized gain of 134% over three years. But EPS was only up 118% per year, in the exact same period. And the 26% profit boost in the last year certainly seems impressive at first glance. But in comparison, EPS only increased by 20% over the same period. So you can see that the dilution has had a bit of an impact on shareholders.

Changes in the share price do tend to reflect changes in earnings per share, in the long run. So IKD shareholders will want to see that EPS figure continue to increase. But on the other hand, we'd be far less excited to learn profit (but not EPS) was improving. For that reason, you could say that EPS is more important that net income in the long run, assuming the goal is to assess whether a company's share price might grow.

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.

How Do Unusual Items Influence Profit?

Alongside that dilution, it's also important to note that IKD's profit was boosted by unusual items worth CN¥101m in the last twelve months. 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 IKD's Profit Performance

To sum it all up, IKD got a nice boost to profit from unusual items; without that, its statutory results would have looked worse. And furthermore, it went and issued plenty of new shares, ensuring that each shareholder (who did not tip more money in) now owns a smaller proportion of the company. For the reasons mentioned above, we think that a perfunctory glance at IKD's statutory profits might make it look better than it really is on an underlying level. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. For example - IKD has 2 warning signs we think you should be aware of.

Our examination of IKD 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 with high insider ownership.

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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.