The stock was sluggish on the back of Innodata Inc.'s (NASDAQ:INOD) recent earnings report. Along with the solid headline numbers, we think that investors have some reasons for optimism.
Examining Cashflow Against Innodata's Earnings
In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). To get the accrual ratio we first subtract FCF from profit for a period, and then divide that number by the average operating assets for the period. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.
That means a negative accrual ratio is a good thing, because it shows that the company is bringing in more free cash flow than its profit would suggest. That is not intended to imply we should worry about a positive accrual ratio, but it's worth noting where the accrual ratio is rather high. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.
Innodata has an accrual ratio of -1.92 for the year to September 2026. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. Indeed, in the last twelve months it reported free cash flow of US$83m, well over the US$48.5m it reported in profit. Innodata shareholders are no doubt pleased that free cash flow improved over the last twelve months. Notably, the company has issued new shares, thus diluting existing shareholders and reducing their share of future earnings.
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.
To understand the value of a company's earnings growth, it is imperative to consider any dilution of shareholders' interests. Innodata expanded the number of shares on issue by 8.0% over the last year. That means its earnings are split among 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 Innodata's historical EPS growth by clicking on this link.
A Look At The Impact Of Innodata's Dilution On Its Earnings Per Share (EPS)
Innodata was losing money three years ago. The good news is that profit was up 44% in the last twelve months. On the other hand, earnings per share are only up 36% over the same period. So you can see that the dilution has had a bit of an impact on shareholders.
Changes in the share price do tend to reflect changes in earnings per share, in the long run. So Innodata 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.
Our Take On Innodata's Profit Performance
At the end of the day, Innodata is diluting shareholders which will dampen earnings per share growth, but its accrual ratio showed it can back up its profits with free cash flow. Considering all the aforementioned, we'd venture that Innodata's profit result is a pretty good guide to its true profitability, albeit a bit on the conservative side. So while earnings quality is important, it's equally important to consider the risks facing Innodata at this point in time. In terms of investment risks, we've identified 1 warning sign with Innodata, and understanding it should be part of your investment process.
Our examination of Innodata has focussed on certain factors that can make its earnings look better than they are. 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 with significant insider holdings to be useful.
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