Far East Hotels and Entertainment's (HKG:37) Earnings Are Of Questionable Quality

Despite posting some strong earnings, the market for Far East Hotels and Entertainment Limited's (HKG:37) stock hasn't moved much. Our analysis suggests that shareholders have noticed something concerning in the numbers.

View our latest analysis for Far East Hotels and Entertainment

In order to understand the potential for per share returns, it is essential to consider how much a company is diluting shareholders. As it happens, Far East Hotels and Entertainment issued 20% more new shares over the last year. As a result, its net income is now split between 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. Check out Far East Hotels and Entertainment's historical EPS growth by clicking on this link.

A Look At The Impact Of Far East Hotels and Entertainment's Dilution on Its Earnings Per Share (EPS).

As it happens, we don't know how much the company made or lost three years ago, because we don't have the data. 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. What we do know is that while it's great to see a profit over the last twelve months, that profit would have been better, on a per share basis, if the company hadn't needed to issue shares. And so, you can see quite clearly that dilution is influencing shareholder earnings.

In the long term, if Far East Hotels and Entertainment'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.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Far East Hotels and Entertainment.

The Impact Of Unusual Items On Profit

Alongside that dilution, it's also important to note that Far East Hotels and Entertainment's profit was boosted by unusual items worth HK$1.1m 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. And that's as you'd expect, given these boosts are described as 'unusual'. Assuming those unusual items don't show up again in the current year, we'd thus expect profit to be weaker next year (in the absence of business growth, that is).

Our Take On Far East Hotels and Entertainment's Profit Performance

To sum it all up, Far East Hotels and Entertainment got a nice boost to profit from unusual items; without that, its statutory results would have looked worse. 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. Considering all this we'd argue Far East Hotels and Entertainment's profits probably give an overly generous impression of its sustainable level of profitability. So while earnings quality is important, it's equally important to consider the risks facing Far East Hotels and Entertainment at this point in time. You'd be interested to know, that we found 2 warning signs for Far East Hotels and Entertainment 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, 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. 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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