Are China Shengmu Organic Milk's (HKG:1432) Statutory Earnings A Good Guide To Its Underlying Profitability?

Many investors consider it preferable to invest in profitable companies over unprofitable ones, because profitability suggests a business is sustainable. That said, the current statutory profit is not always a good guide to a company's underlying profitability. Today we'll focus on whether this year's statutory profits are a good guide to understanding China Shengmu Organic Milk (HKG:1432).

It's good to see that over the last twelve months China Shengmu Organic Milk made a profit of CN¥244.4m on revenue of CN¥2.59b.

View our latest analysis for China Shengmu Organic Milk

Of course, when it comes to statutory profit, the devil is often in the detail, and we can get a better sense for a company by diving deeper into the financial statements. In this article we'll look at how China Shengmu Organic Milk is impacting shareholders by issuing new shares, as well as how unusual items have affected the income line. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of China Shengmu Organic Milk.

In order to understand the potential for per share returns, it is essential to consider how much a company is diluting shareholders. China Shengmu Organic Milk expanded the number of shares on issue by 32% over the last year. As a result, its net income is now split between 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. Check out China Shengmu Organic Milk's historical EPS growth by clicking on this link.

How Is Dilution Impacting China Shengmu Organic Milk's Earnings Per Share? (EPS)

Unfortunately, we don't have any visibility into its profits three years back, because we lack 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. 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). So you can see that the dilution has had a fairly significant impact on shareholders.

In the long term, if China Shengmu Organic Milk's earnings per share can increase, then the share price should too. 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.

How Do Unusual Items Influence Profit?

On top of the dilution, we should also consider the CN¥295m impact of unusual items in the last year, which had the effect of suppressing profit. While deductions due to unusual items are disappointing in the first instance, there is a silver lining. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And, after all, that's exactly what the accounting terminology implies. If China Shengmu Organic Milk doesn't see those unusual expenses repeat, then all else being equal we'd expect its profit to increase over the coming year.

Our Take On China Shengmu Organic Milk's Profit Performance

China Shengmu Organic Milk suffered from unusual items which depressed its profit in its last report; if that is not repeated then profit should be higher, all else being equal. But unfortunately the dilution means that shareholders now own a smaller proportion of the company (assuming they maintained the same number of shares). That will weigh on earnings per share, even if it is not reflected in net income. Given the contrasting considerations, we don't have a strong view as to whether China Shengmu Organic Milk's profits are an apt reflection of its underlying potential for profit. If you want to do dive deeper into China Shengmu Organic Milk, you'd also look into what risks it is currently facing. For example, we've found that China Shengmu Organic Milk has 5 warning signs (1 is significant!) that deserve your attention before going any further with your analysis.

Our examination of China Shengmu Organic Milk has focussed on certain factors that can make its earnings look better than they are. But there is always more to discover if you are capable of focussing your mind on minutiae. 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 that insiders are buying.

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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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