Zero-debt allows substantial financial flexibility, especially for small-cap companies like DSP Group, Inc. (NASDAQ:DSPG), as the company does not have to adhere to strict debt covenants. However, it also faces higher cost of capital given interest cost is generally lower than equity. Zero-debt can alleviate some risk associated with the company meeting debt obligations, but this doesn’t automatically mean DSPG has outstanding financial strength. I will take you through a few basic checks to assess the financial health of companies with no debt.
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Is financial flexibility worth the lower cost of capital?
There are well-known benefits of including debt in capital structure, primarily a lower cost of capital. Though, the trade-offs are that lenders require stricter capital management requirements, in addition to having a higher claim on company assets relative to shareholders. The lack of debt on DSPG’s balance sheet may be because it does not have access to cheap capital, or it may believe this trade-off is not worth it. Choosing financial flexibility over capital returns make sense if DSPG is a high-growth company. DSPG delivered a negative revenue growth of -4.8%. While its negative growth hardly justifies opting for zero-debt, if the decline sustains, it may find it hard to raise debt at an acceptable cost.
Does DSPG’s liquid assets cover its short-term commitments?
Given zero long-term debt on its balance sheet, DSP Group has no solvency issues, which is 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$22m, the company has been able to meet these obligations given the level of current assets of US$79m, with a current ratio of 3.63x. Having said that, a ratio above 3x may be considered excessive by some investors.
DSPG is a fast-growing firm, which supports having have zero-debt and financial freedom to continue to ramp up growth. Since there is also no concerns around DSPG’s liquidity needs, this may be its optimal capital structure for the time being. In the future, its financial position may change. I admit this is a fairly basic analysis for DSPG’s financial health. Other important fundamentals need to be considered alongside. I suggest you continue to research DSP Group to get a better picture of the stock by looking at:
- Future Outlook: What are well-informed industry analysts predicting for DSPG’s future growth? Take a look at our free research report of analyst consensus for DSPG’s outlook.
- Valuation: What is DSPG 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 DSPG 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 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 firstname.lastname@example.org.