Investors were disappointed with Taoping Inc.'s (NASDAQ:TAOP) recent earnings release. We did some analysis and believe that they might be concerned about some weak underlying factors.

View our latest analysis for Taoping

Examining Cashflow Against Taoping's Earnings

Many investors haven't heard of the accrual ratio from cashflow, but it is actually a useful measure of how well a company's profit is backed up by free cash flow (FCF) during a given period. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. The ratio shows us how much a company's profit exceeds its FCF.

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. While it's not a problem to have a positive accrual ratio, indicating a certain level of non-cash profits, a high accrual ratio is arguably a bad thing, because it indicates paper profits are not matched by cash flow. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Over the twelve months to June 2024, Taoping recorded an accrual ratio of 0.35. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, raising questions about how useful that profit figure really is. Over the last year it actually had negative free cash flow of US$5.6m, in contrast to the aforementioned profit of US$2.15m. We also note that Taoping's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of US$5.6m. Notably, the company has issued new shares, thus diluting existing shareholders and reducing their share of future earnings.

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

To understand the value of a company's earnings growth, it is imperative to consider any dilution of shareholders' interests. Taoping expanded the number of shares on issue by 129% over the last year. Therefore, each share now receives a smaller portion of profit. 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. You can see a chart of Taoping's EPS by clicking here.

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

Taoping was losing money three years ago. Zooming in to the last year, we still can't talk about growth rates coherently, since it made a loss last year. But mathematics aside, it is always good to see when a formerly unprofitable business come good (though we accept profit would have been higher if dilution had not been required). And so, you can see quite clearly that dilution is having a rather significant impact on shareholders.

If Taoping's EPS can grow over time then that drastically improves the chances of the share price moving in the same direction. But on the other hand, we'd be far less excited to learn profit (but not EPS) was improving. 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.

Our Take On Taoping's Profit Performance

As it turns out, Taoping couldn't match its profit with cashflow and its dilution means that shareholders own less of the company than the did before (unless they bought more shares). For the reasons mentioned above, we think that a perfunctory glance at Taoping's statutory profits might make it look better than it really is on an underlying level. If you'd like to know more about Taoping as a business, it's important to be aware of any risks it's facing. Our analysis shows 5 warning signs for Taoping (4 make us uncomfortable!) and we strongly recommend you look at them before investing.

Our examination of Taoping 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 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. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks with high insider ownership.

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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.