Lucapa Diamond's (ASX:LOM) Earnings Aren't As Good As They Appear

Lucapa Diamond Company Limited's (ASX:LOM) stock rose after it released a robust earnings report. While the headline numbers were strong, we found some underlying problems once we started looking at what drove earnings.

See our latest analysis for Lucapa Diamond

One essential aspect of assessing earnings quality is to look at how much a company is diluting shareholders. As it happens, Lucapa Diamond issued 98% more new shares over the last year. That means its earnings are split among a greater number of shares. Per share metrics like EPS help us understand how much actual shareholders are benefitting from the company's profits, while the net income level gives us a better view of the company's absolute size. Check out Lucapa Diamond's historical EPS growth by clicking on this link.

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

Lucapa Diamond was losing money three years ago. And even focusing only on the last twelve months, we don't have a meaningful growth rate because it made a loss a year ago, too. But mathematics aside, it is always good to see when a formerly unprofitable business come good (though we accept profit would have been higher if dilution had not been required). Therefore, one can observe that the dilution is having a fairly profound effect on shareholder returns.

If Lucapa Diamond's EPS can grow over time then that drastically improves the chances of the share price moving in the same direction. However, if its profit increases while its earnings per share stay flat (or even fall) then shareholders might not see much benefit. 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.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Lucapa Diamond.

The Impact Of Unusual Items On Profit

Alongside that dilution, it's also important to note that Lucapa Diamond's profit was boosted by unusual items worth US$1.4m in the last twelve months. While we like to see profit increases, we tend to be a little more cautious when unusual items have made a big contribution. When we crunched the numbers on thousands of publicly listed companies, we found that a boost from unusual items in a given year is often not repeated the next year. Which is hardly surprising, given the name. Lucapa Diamond had a rather significant contribution from unusual items relative to its profit to June 2021. As a result, we can surmise that the unusual items are making its statutory profit significantly stronger than it would otherwise be.

Our Take On Lucapa Diamond's Profit Performance

In its last report Lucapa Diamond 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 all the reasons mentioned above, we think that, at a glance, Lucapa Diamond's statutory profits could be considered to be low quality, because they are likely to give investors an overly positive impression of the company. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. Be aware that Lucapa Diamond is showing 2 warning signs in our investment analysis and 1 of those doesn't sit too well with us...

In this article we've looked at a number of factors that can impair the utility of profit numbers, and we've come away cautious. 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. 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.
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