TORM's (CPH:TRMD A) Solid Earnings May Rest On Weak Foundations

TORM plc's (CPH:TRMD A) healthy profit numbers didn't contain any surprises for investors. However the statutory profit number doesn't tell the whole story, and we have found some factors which might be of concern to shareholders.

See our latest analysis for TORM

In order to understand the potential for per share returns, it is essential to consider how much a company is diluting shareholders. TORM expanded the number of shares on issue by 14% over the last year. 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. You can see a chart of TORM's EPS by clicking here.

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

Three years ago, TORM lost money. On the bright side, in the last twelve months it grew profit by 3.9%. But earnings per share are actually down 5.0%, over that same period. This is a great example of why it's rather imprudent to rely only on net income as a growth measure. So you can see that the dilution has had a bit of an impact on shareholders.

In the long term, if TORM'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 the ordinary retail shareholder, EPS is a great measure to check your hypothetical "share" of the company's profit.

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 TORM's profit was boosted by unusual items worth US$79m 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 analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. Which is hardly surprising, given the name. If TORM 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 TORM's Profit Performance

In its last report TORM benefitted from unusual items which boosted its profit, which could make the profit seem better than it really is on a sustainable basis. 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 TORM's statutory profits might make it look better than it really is on an underlying level. So while earnings quality is important, it's equally important to consider the risks facing TORM at this point in time. For instance, we've identified 4 warning signs for TORM (1 is significant) you should be familiar with.

Our examination of TORM 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. 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 with significant insider holdings to be useful.

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.