We're Not So Sure You Should Rely on Abhotel's (TYO:6565) Statutory Earnings

Statistically speaking, it is less risky to invest in profitable companies than in unprofitable ones. Having said that, sometimes statutory profit levels are not a good guide to ongoing profitability, because some short term one-off factor has impacted profit levels. In this article, we'll look at how useful this year's statutory profit is, when analysing Abhotel (TYO:6565).

While Abhotel was able to generate revenue of JP¥5.10b in the last twelve months, we think its profit result of JP¥304.0m was more important. While it managed to grow its revenue over the last three years, its profit has moved in the other direction, as you can see in the chart below.

View our latest analysis for Abhotel

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. Therefore, today we will consider the nature of Abhotel's statutory earnings with reference to its dilution of shareholders and the impact of unusual items. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Abhotel.

To understand the value of a company's earnings growth, it is imperative to consider any dilution of shareholders' interests. In fact, Abhotel increased the number of shares on issue by 12% 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. Check out Abhotel's historical EPS growth by clicking on this link.

A Look At The Impact Of Abhotel's Dilution on Its Earnings Per Share (EPS).

Abhotel's net profit dropped by 56% per year over the last three years. And even focusing only on the last twelve months, we see profit is down 68%. Sadly, earnings per share fell further, down a full 68% in that time. So you can see that the dilution has had a bit of an impact on shareholders. Therefore, the dilution is having a noteworthy influence on shareholder returns. And so, you can see quite clearly that dilution is influencing shareholder earnings.

If Abhotel's EPS can grow over time then that drastically improves the chances of the share price moving in the same direction. 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.

The Impact Of Unusual Items On Profit

Finally, we should also consider the fact that unusual items boosted Abhotel's net profit by JP¥140m over the last year. While we like to see profit increases, we tend to be a little more cautious when unusual items have made a big contribution. We ran the numbers on most publicly listed companies worldwide, and it's very common for unusual items to be once-off in nature. And that's as you'd expect, given these boosts are described as 'unusual'. We can see that Abhotel's positive unusual items were quite significant relative to its profit in the year to September 2020. All else being equal, this would likely have the effect of making the statutory profit a poor guide to underlying earnings power.

Our Take On Abhotel's Profit Performance

To sum it all up, Abhotel 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. For the reasons mentioned above, we think that a perfunctory glance at Abhotel's statutory profits might make it look better than it really is on an underlying level. 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. For example, we've found that Abhotel has 4 warning signs (1 is a bit concerning!) that deserve your attention before going any further with your analysis.

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 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. 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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