Dilution Lurks at AOB

On Monday, Motley Fool Hidden Gems pick American Oriental Bioengineering (Nasdaq: AOB  ) released some stellar year-over-year growth numbers. But investors should be wary of the growing share count fueling that performance.

In the second quarter, AOB posted a 74% revenue increase and a 43% jump in net income versus last year. While nearly any company would celebrate these sort of top and bottom-line growth rates, it's important to keep in mind that AOB primarily grows its health-care-supplements business through acquisitions -- specifically, acquisitions funded by dilutive equity financings.

If a company is furiously selling new shares to buy its growth, even a 100% increase in net income from one period to the next can leave shareholders with a smaller piece of the earnings pie. That's partly why you see AOB's earnings per share increasing more slowly than its revenue and net income's torrid pace:

Quarter

Net Income

Net Income Growth (YOY)

Earnings per share

EPS Growth (YOY)

Q2 2008

$13.9 million

43%

$0.18

20%

Q1 2008

$9.4 million

46%

$0.12

20%

Q4 2007

$15.3 million

40%

$0.20

18%

Q3 2007

$11.9 million

58%

$0.16

33%

This chart alone is not enough to prove whether AOB's dilution has helped or hurt the business; that depends on how fast the company can grow in the future. After all, other consumer health-care companies like Chattem (Nasdaq: CHTT  ) and Johnson & Johnson (NYSE: JNJ  ) have shown that "growth through acquisition" can be a winning strategy. Still, investors should make sure that AOB's dilution isn't undermining the gains the company is making in revenue and profits.

Dilutionwise, it's been an interesting few months for AOB. In June, the company paradoxically announced a potentially dilutive financing in conjunction with a share repurchase program, then cancelled the convertible note offering. In July, AOB changed its mind again, completing the convertible note offering. Not surprisingly, since AOB has previously seemed to only raise cash when it's about to make an acquisition, the company announced plans to buy up a large pharmaceutical distribution company.

Potentially dilutive financings can be good or bad, depending on how productively a company uses the cash it raises. So far, AOB's dilutive financings appear to have yielded superior top- and bottom-line growth rates. Investors should hope that the company can keep up that positive trend in future quarters.

Further non-dilutive Foolishness:

American Oriental Bioengineering is an active Motley Fool Hidden Gems pick. Try any of our Foolish newsletter services free for 30 days.

Fool contributor Brian Lawler does not own shares of any company mentioned in this article. Johnson & Johnson is a selection of the Income Investor newsletter. The Fool has an A+ disclosure policy.


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  • Report this Comment On August 13, 2008, at 3:59 PM, joecrocker wrote:

    Ever since I invested in this company several years ago, AOB strategy has always aligned to a long term approach. Their goal is to become the next Johnson & Johnson of China.

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