Rosetta Stone Inc (NYSE:RST) is a small-cap stock with a market capitalization of US$306.09M. While investors primarily focus on the growth potential and competitive landscape of the small-cap companies, they end up ignoring a key aspect, which could be the biggest threat to its existence: its financial health. Why is it important? Software companies, in particular ones that run negative earnings, are more likely to be higher risk. Evaluating financial health as part of your investment thesis is vital. Here are a few basic checks that are good enough to have a broad overview of the company’s financial strength. Nevertheless, given that I have not delve into the company-specifics, I recommend you dig deeper yourself into RST here.
How does RST’s operating cash flow stack up against its debt?
Over the past year, RST has reduced its debt from US$2.56M to US$2.30M . With this debt payback, RST’s cash and short-term investments stands at US$42.96M for investing into the business. Additionally, RST has produced US$19.30M in operating cash flow in the last twelve months, resulting in an operating cash to total debt ratio of 839.22%, signalling that RST’s debt is appropriately covered by operating cash. This ratio can also be a sign of operational efficiency for unprofitable companies as traditional metrics such as return on asset (ROA) requires positive earnings. In RST’s case, it is able to generate 8.39x cash from its debt capital.
Does RST’s liquid assets cover its short-term commitments?
Looking at RST’s most recent US$147.89M liabilities, the company has not been able to meet these commitments with a current assets level of US$90.10M, leading to a 0.61x current account ratio. which is under the appropriate industry ratio of 3x.
Is RST’s debt level acceptable?
With debt reaching 94.92% of equity, RST may be thought of as relatively highly levered. This is not unusual for small-caps as debt tends to be a cheaper and faster source of funding for some businesses. But since RST is currently unprofitable, sustainability of its current state of operations becomes a concern. Maintaining a high level of debt, while revenues are still below costs, can be dangerous as liquidity tends to dry up in unexpected downturns.
Although RST’s debt level is towards the higher end of the spectrum, its cash flow coverage seems adequate to meet debt obligations which means its debt is being efficiently utilised. Though its lack of liquidity raises questions over current asset management practices for the small-cap. This is only a rough assessment of financial health, and I’m sure RST has company-specific issues impacting its capital structure decisions. You should continue to research Rosetta Stone to get a better picture of the stock by looking at:
- Future Outlook: What are well-informed industry analysts predicting for RST’s future growth? Take a look at our free research report of analyst consensus for RST’s outlook.
- Valuation: What is RST worth today? Is the stock undervalued, even when its growth outlook is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether RST is currently mispriced by the market.
- 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 pass 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.