We Think That There Are More Issues For IPH (ASX:IPH) Than Just Sluggish Earnings

The market shrugged off IPH Limited's (ASX:IPH) weak earnings report last week. We looked at the details, and we think that investors may be responding to some encouraging factors.

Check out our latest analysis for IPH

One essential aspect of assessing earnings quality is to look at how much a company is diluting shareholders. In fact, IPH increased the number of shares on issue by 13% over the last twelve months by issuing new shares. That means its earnings are split among a greater number of shares. To celebrate net income while ignoring dilution is like rejoicing because you have a single slice of a larger pizza, but ignoring the fact that the pizza is now cut into many more slices. You can see a chart of IPH's EPS by clicking here.

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

As you can see above, IPH has been growing its net income over the last few years, with an annualized gain of 13% over three years. But EPS was only up 1.1% per year, in the exact same period. Net income was down 5.7% over the last twelve months. But the EPS result was even worse, with the company recording a decline of 12%. So you can see that the dilution has had a bit of an impact on shareholders.

In the long term, if IPH's earnings per share can increase, then the share price should too. 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?

On top of the dilution, we should also consider the AU$19m impact of unusual items in the last year, which had the effect of suppressing profit. While deductions due to unusual items are disappointing in the first instance, there is a silver lining. We looked at thousands of listed companies and found that unusual items are very often one-off in nature. And that's hardly a surprise given these line items are considered unusual. Assuming those unusual expenses don't come up again, we'd therefore expect IPH to produce a higher profit next year, all else being equal.

Our Take On IPH's Profit Performance

To sum it all up, IPH took a hit from unusual items which pushed its profit down; without that, it would have made more money. But unfortunately the dilution means that shareholders now own a smaller proportion of the company (assuming they maintained the same number of shares). That will weigh on earnings per share, even if it is not reflected in net income. Based on these factors, it's hard to tell if IPH's profits are a reasonable reflection of its underlying profitability. So while earnings quality is important, it's equally important to consider the risks facing IPH at this point in time. You'd be interested to know, that we found 3 warning signs for IPH and you'll want to know about them.

In this article we've looked at a number of factors that can impair the utility of profit numbers, as a guide to a business. But there is always more to discover if you are capable of focussing your mind on minutiae. Some people consider a high return on equity to be a good sign of a quality business. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.