Here's Why We Don't Think Hong Fok's (SGX:H30) Statutory Earnings Reflect Its Underlying Earnings Potential

It might be old fashioned, but we really like to invest in companies that make a profit, each and every year. 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 Hong Fok (SGX:H30).

We like the fact that Hong Fok made a profit of S$109.0m on its revenue of S$109.6m, in the last year. In the chart below, you can see that its profit and revenue have both grown over the last three years, albeit not in the last year.

See our latest analysis for Hong Fok

Not all profits are equal, and we can learn more about the nature of a company's past profitability by diving deeper into the financial statements. In this article we'll look at how Hong Fok 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 Hong Fok.

To understand the value of a company's earnings growth, it is imperative to consider any dilution of shareholders' interests. In fact, Hong Fok increased the number of shares on issue by 24% over the last twelve months by issuing new shares. As a result, its net income is now split between a greater number of shares. Per share metrics like EPS help us understand how much actual shareholders are benefitting from the company's profits, while the net income level gives us a better view of the company's absolute size. Check out Hong Fok's historical EPS growth by clicking on this link.

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

As you can see above, Hong Fok has been growing its net income over the last few years, with an annualized gain of 47% over three years. Net income was down 43% over the last twelve months. Unfortunately for shareholders, though, the earnings per share result was even worse, declining 42%. Therefore, one can observe that the dilution is having a fairly profound effect on shareholder returns.

If Hong Fok'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 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?

Alongside that dilution, it's also important to note that Hong Fok's profit was boosted by unusual items worth S$101m 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 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. We can see that Hong Fok's positive unusual items were quite significant relative to its profit in the year to June 2020. As a result, we can surmise that the unusual items are making its statutory profit significantly stronger than it would otherwise be.

Our Take On Hong Fok's Profit Performance

In its last report Hong Fok 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. Considering all this we'd argue Hong Fok'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 Hong Fok at this point in time. At Simply Wall St, we found 3 warning signs for Hong Fok and we think they deserve your attention.

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. 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 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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