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Acacia Research Corporation (NASDAQ:ACTG), which has zero-debt on its balance sheet, can maximize capital returns by increasing debt due to its lower cost of capital. However, the trade-off is ACTG will have to follow strict debt obligations which will reduce its financial flexibility. While zero-debt makes the due diligence for potential investors less nerve-racking, it poses a new question: how should they assess the financial strength of such companies? I will take you through a few basic checks to assess the financial health of companies with no debt.
Is ACTG right in choosing financial flexibility over lower cost of capital?
Debt capital generally has lower cost of capital compared to equity funding. But the downside of having debt in a company’s balance sheet is the debtholder’s higher claim on its assets in the case of liquidation, as well as stricter capital management requirements. Either ACTG does not have access to cheap capital, or it may believe this trade-off is not worth it. This makes sense only if the company has a competitive edge and is growing fast off its equity capital. A single-digit revenue growth of 2.2% for ACTG is considerably low for a small-cap company. While its low growth hardly justifies opting for zero-debt, the company may have high growth projects in the pipeline to justify the trade-off.
Can ACTG meet its short-term obligations with the cash in hand?
Since Acacia Research doesn’t have any debt on its balance sheet, it doesn’t have any solvency issues, which is a term used to describe the company’s ability to meet its long-term obligations. However, another measure of financial health is its short-term obligations, which is known as liquidity. These include payments to suppliers, employees and other stakeholders. With current liabilities at US$16m, it appears that the company has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 9.66x. Having said that, a ratio greater than 3x may be considered high by some.
As a high-growth company, it may be beneficial for ACTG to have some financial flexibility, hence zero-debt. Since there is also no concerns around ACTG’s liquidity needs, this may be its optimal capital structure for the time being. Going forward, ACTG’s financial situation may change. Keep in mind I haven’t considered other factors such as how ACTG has been performing in the past. You should continue to research Acacia Research to get a better picture of the stock by looking at:
Historical Performance: What has ACTG’s returns been like over the past? Go into more detail in the past track record analysis and take a look at the free visual representations of our analysis for more clarity.
Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at email@example.com.