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Balance Sheet Buys- 4 Favorite Small Caps

Coronavirus and widespread expectations of recession have put corporate balance sheets under the microscope, notes Richard Moroney, editor of the specialized small cap advisory service, Upside Stocks.

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For investors trying to assess what stocks are positioned to weather the storm, we suggest starting with the Quadrix® Financial Strength score. It considers a variety of balance-sheet and profitability metrics, including four of our favorite ratios:

Cash flow/interest expense gauges the ability to pay interest expense from operating cash flow — the lifeblood of most companies.

Cash flow/total debt evaluates the ability to pay all debt obligations.

Interest coverage uses earnings before interest and taxes to measure how well interest costs are covered.

Long-term debt/total capital, which divides long-term debt by the sum of long-term debt plus equity, shows the percentage of operations financed by long-term borrowings.

Financial Strength scores can’t capture every balance-sheet flaw, and few companies excel in all metrics. Still, the scores help gauge a company’s financial footing. We screened for stocks with above-average Financial Strength scores and solid ranks four our four key ratios. We also looked for companies with sizable cash reserves that are growing both cash flow and free cash flow.

Ciena (CIEN), the optical networking company, had $837 million in cash reserves, up 25% from a year earlier. Over the last 12 months, cash flow more than doubled to $467 million.

Ciena is experiencing disruptions and delays to its supply chain, mostly in China. Despite the setbacks, the company is seeing healthy demand for gear used in cloud applications and 5G networks.

FormFactor (FORM) has a solid balance sheet and surging cash flow that is helping drive growth. A leading provider of test and measurement technologies, FormFactor’s core products are probe cards used to test wafer and chip designs.

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At the end of 2019, the company had $145 million in cash on hand but only $45 million in long term debt. Trailing 12-month free cash flow has more than doubled to $100, providing ample flexibility to capitalize on internal expansion and acquisitions.

Medpace (MEDP) has plenty of balance-sheet fortitude. The stock boasts ranks of 95 for cash flow to total debt and 82 for long-term debt/ total capital. On Dec. 31, the company had $132 million in cash, up from $79 million at the end of September. Trailing 12-month cash flow totaled $202 million, up 29% from a year earlier.

A leading clinical-research organization (CRO), Medpace helps medical device and pharmaceutical companies develop and test new products. Earning a Quadrix Momentum score of 88 and Quality score of 94, Medpace is a top pick for year-ahead gains. The stock is a Best Buy.

Mitek Systems (MITK) — a leading provider of mobile banking solutions — earns a Financial Strength score of 80, or double the average of 40 for application- software stocks. The balance sheet holds only $7 million in long-term debt, versus a cash balance of $15 million. Over the last 12 months, cash flow surged 220% to $17 million.

Mitek’s Overall score of 91 ranks No. 3 in its industry group. Used by more than 6,500 financial firms, Mitek’s software is used to remotely deposit checks — a timely service during social distancing. Its products also help verify customer identity and prevent fraud. Mitek is rated Buy.

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