Following the solid earnings report from carsales.com Ltd (ASX:CAR), the market responded by bidding up the stock price. However, we think that shareholders should be cautious as we found some worrying factors underlying the profit.
In order to understand the potential for per share returns, it is essential to consider how much a company is diluting shareholders. In fact, carsales.com increased the number of shares on issue by 15% over the last twelve months by issuing new shares. As a result, its net income is now split between 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. You can see a chart of carsales.com's EPS by clicking here.
A Look At The Impact Of carsales.com's Dilution on Its Earnings Per Share (EPS).
Unfortunately, carsales.com's profit is down 27% per year over three years. On the bright side, in the last twelve months it grew profit by 9.3%. But EPS was less impressive, up only 7.9% in that time. 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 it will certainly be a positive for shareholders if carsales.com can grow EPS persistently. 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.
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.
Our Take On carsales.com's Profit Performance
carsales.com shareholders should keep in mind how many new shares it is issuing, because, dilution clearly has the power to severely impact shareholder returns. Therefore, it seems possible to us that carsales.com's true underlying earnings power is actually less than its statutory profit. But at least holders can take some solace from the 7.9% EPS growth in the last year. 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. So while earnings quality is important, it's equally important to consider the risks facing carsales.com at this point in time. For example, we've discovered 2 warning signs that you should run your eye over to get a better picture of carsales.com.
Today we've zoomed in on a single data point to better understand the nature of carsales.com's profit. 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. 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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