Shelf Drilling's (OB:SHLF) Solid Profits Have Weak Fundamentals

Last week's profit announcement from Shelf Drilling, Ltd. (OB:SHLF) was underwhelming for investors, despite headline numbers being robust. We think that the market might be paying attention to some underlying factors that they find to be concerning.

Check out our latest analysis for Shelf Drilling

One essential aspect of assessing earnings quality is to look at how much a company is diluting shareholders. Shelf Drilling expanded the number of shares on issue by 10% 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. You can see a chart of Shelf Drilling's EPS by clicking here.

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

Three years ago, Shelf Drilling lost money. Zooming in to the last year, we still can't talk about growth rates coherently, since it made a loss last year. 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). And so, you can see quite clearly that dilution is influencing shareholder earnings.

If Shelf Drilling's EPS can grow over time then that drastically improves the chances of the share price moving in the same direction. However, if its profit increases while its earnings per share stay flat (or even fall) then shareholders might not see much benefit. 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 Shelf Drilling's profit suffered from unusual items, which reduced profit by US$32m in the last twelve months. It's never great to see unusual items costing the company profits, but on the upside, things might improve sooner rather than later. We looked at thousands of listed companies and found that unusual items are very often one-off in nature. And that's hardly a surprise given these line items are considered unusual. If Shelf Drilling 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 Shelf Drilling's Profit Performance

To sum it all up, Shelf Drilling took a hit from unusual items which pushed its profit down; without that, it would have made more money. 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 Shelf Drilling's profits are an apt reflection of its underlying potential for profit. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. Every company has risks, and we've spotted 4 warning signs for Shelf Drilling (of which 1 makes us a bit uncomfortable!) you should know about.

Our examination of Shelf Drilling 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. 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.

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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.