We Think That There Are Issues Underlying Xuchang Yuandong Drive ShaftLtd's (SZSE:002406) Earnings

Investors were disappointed with Xuchang Yuandong Drive Shaft Co.Ltd's (SZSE:002406) earnings, despite the strong profit numbers. Our analysis uncovered some concerning factors that we believe the market might be paying attention to.

Check out our latest analysis for Xuchang Yuandong Drive ShaftLtd

In order to understand the potential for per share returns, it is essential to consider how much a company is diluting shareholders. In fact, Xuchang Yuandong Drive ShaftLtd increased the number of shares on issue by 9.6% 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 Xuchang Yuandong Drive ShaftLtd's EPS by clicking here.

How Is Dilution Impacting Xuchang Yuandong Drive ShaftLtd's Earnings Per Share (EPS)?

Xuchang Yuandong Drive ShaftLtd's net profit dropped by 57% per year over the last three years. The good news is that profit was up 42% in the last twelve months. But EPS was less impressive, up only 12% 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 Xuchang Yuandong Drive ShaftLtd shareholders will want to see that EPS figure continue to increase. 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 Xuchang Yuandong Drive ShaftLtd.

The Impact Of Unusual Items On Profit

Alongside that dilution, it's also important to note that Xuchang Yuandong Drive ShaftLtd's profit was boosted by unusual items worth CN¥23m in the last twelve months. We can't deny that higher profits generally leave us optimistic, but we'd prefer it if the profit were to be sustainable. 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. And, after all, that's exactly what the accounting terminology implies. If Xuchang Yuandong Drive ShaftLtd doesn't see that contribution repeat, then all else being equal we'd expect its profit to drop over the current year.

Our Take On Xuchang Yuandong Drive ShaftLtd's Profit Performance

In its last report Xuchang Yuandong Drive ShaftLtd 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. Considering all this we'd argue Xuchang Yuandong Drive ShaftLtd's profits probably give an overly generous impression of its sustainable level of profitability. In light of this, if you'd like to do more analysis on the company, it's vital to be informed of the risks involved. Be aware that Xuchang Yuandong Drive ShaftLtd is showing 3 warning signs in our investment analysis and 1 of those is concerning...

Our examination of Xuchang Yuandong Drive ShaftLtd 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. 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.

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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.