The direct benefit for Deswell Industries, Inc. (NASDAQ:DSWL), which sports a zero-debt capital structure, to include debt in its capital structure is the reduced cost of capital. However, the trade-off is DSWL will have to adhere to stricter debt covenants and have less 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 recommend you look at the following hurdles to assess DSWL’s financial health.
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Does DSWL’s growth rate justify its decision for financial flexibility over lower cost of capital?
Debt funding can be cheaper than issuing new equity due to lower interest cost on debt. 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 DSWL 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 double-digit revenue growth of 22% is considered relatively high for a small-cap company like DSWL. Therefore, the company’s decision to choose financial flexibility is justified as it may need headroom to borrow in the future to sustain high growth.
Can DSWL pay its short-term liabilities?
Since Deswell Industries 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. But another important aspect of financial health is liquidity: the company’s ability to meet short-term obligations, including payments to suppliers and employees. At the current liabilities level of US$19m, it appears that the company has been able to meet these obligations given the level of current assets of US$72m, with a current ratio of 3.86x. However, a ratio greater than 3x may be considered by some to be quite high, however this is not necessarily a negative for the company.
Having no debt on the books means DSWL has more financial freedom to keep growing at its current fast rate. Since there is also no concerns around DSWL’s liquidity needs, this may be its optimal capital structure for the time being. Moving forward, its financial position may change. I admit this is a fairly basic analysis for DSWL’s financial health. Other important fundamentals need to be considered alongside. I recommend you continue to research Deswell Industries to get a better picture of the stock by looking at:
- Future Outlook: What are well-informed industry analysts predicting for DSWL’s future growth? Take a look at our free research report of analyst consensus for DSWL’s outlook.
- Historical Performance: What has DSWL’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.