Innovation Inc. (TSE:3970) announced strong profits, but the stock was stagnant. Our analysis suggests that shareholders have noticed something concerning in the numbers.

View our latest analysis for Innovation

One essential aspect of assessing earnings quality is to look at how much a company is diluting shareholders. As it happens, Innovation issued 7.8% more new shares over the last year. Therefore, each share now receives a smaller portion of profit. 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. You can see a chart of Innovation’s EPS by clicking here.

How Is Dilution Impacting Innovation’s Earnings Per Share (EPS)?

Innovation’s net profit dropped by 17% per year over the last three years. The good news is that profit was up 294% in the last twelve months. On the other hand, earnings per share are only up 278% over the same period. So you can see that the dilution has had a bit of an impact on shareholders.

In the long term, earnings per share growth should beget share price growth. So Innovation shareholders will want to see that EPS figure continue to increase. But on the other hand, we’d be far less excited to learn profit (but not EPS) was improving. For the ordinary retail shareholder, EPS is a great measure to check your hypothetical “share” of the company’s profit.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Innovation.

The Impact Of Unusual Items On Profit

Alongside that dilution, it’s also important to note that Innovation’s profit was boosted by unusual items worth JP¥31m in the last twelve months. We can’t deny that higher profits generally leave us optimistic, but we’d prefer it if the profit were to be sustainable. 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, after all, that’s exactly what the accounting terminology implies. 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 Innovation’s Profit Performance

In its last report Innovation 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. For the reasons mentioned above, we think that a perfunctory glance at Innovation’s statutory profits might make it look better than it really is on an underlying level. If you’d like to know more about Innovation as a business, it’s important to be aware of any risks it’s facing. For example – Innovation has 3 warning signs we think you should be aware of.

Our examination of Innovation has focussed on certain factors that can make its earnings look better than they are. And, on that basis, we are somewhat skeptical. 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 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.