Last week's earnings announcement from Watsco, Inc. (NYSE:WSO) was disappointing to investors, with a sluggish profit figure. We did some further digging and think they have a few more reasons to be concerned beyond the statutory profit.

One essential aspect of assessing earnings quality is to look at how much a company is diluting shareholders. In fact, Watsco increased the number of shares on issue by 7.3% 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. You can see a chart of Watsco's EPS by clicking here.

A Look At The Impact Of Watsco's Dilution On Its Earnings Per Share (EPS)

Watsco's net profit dropped by 16% per year over the last three years. And even focusing only on the last twelve months, we see profit is down 6.0%. Like a sack of potatoes thrown from a delivery truck, EPS fell harder, down 6.6% in the same period. Therefore, the dilution is having a noteworthy influence on shareholder returns.

In the long term, if Watsco's earnings per share can increase, then the share price should too. 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.

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.

Our Take On Watsco's Profit Performance

Watsco issued shares during the year, and that means its EPS performance lags its net income growth. Therefore, it seems possible to us that Watsco's true underlying earnings power is actually less than its statutory profit. In further bad news, its earnings per share decreased in the last year. At the end of the day, it's essential to consider more than just the factors above, if you want to understand the company properly. So while earnings quality is important, it's equally important to consider the risks facing Watsco at this point in time.

Today we've zoomed in on a single data point to better understand the nature of Watsco's profit. 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.

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.