The direct benefit for Koss Corporation (NASDAQ:KOSS), 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 KOSS 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 will take you through a few basic checks to assess the financial health of companies with no debt. Check out our latest analysis for Koss
Is KOSS right in choosing financial flexibility over lower cost of capital?
There are well-known benefits of including debt in capital structure, primarily a lower cost of capital. However, the trade-off is debtholders’ higher claim on company assets in the event of liquidation and stringent obligations around capital management. The lack of debt on KOSS’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 KOSS is a high-growth company. Opposite to the high growth we were expecting, KOSS’s negative revenue growth of -7.49% hardly justifies opting for zero-debt. If the decline sustains, it may find it hard to raise debt at an acceptable cost.
Can KOSS pay its short-term liabilities?
Since Koss 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 $3.4M, it seems that the business has been able to meet these commitments with a current assets level of $12.9M, leading to a 3.82x current account ratio. Though, a ratio greater than 3x may be considered as too high, as KOSS could be holding too much capital in a low-return investment environment.
KOSS’s soft top-line growth means being in a zero-debt position isn’t always optimal. Shareholders should understand why the company isn’t opting for cheaper cost of capital to fund future growth, and whether the company needs financial flexibility at this point in time. Keep in mind I haven’t considered other factors such as how KOSS has been performing in the past. I suggest you continue to research Koss to get a better picture of the stock by looking at:
- 1. Valuation: What is KOSS 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 KOSS is currently mispriced by the market.
- 2. Historical Performance: What has KOSS’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.
- 3. 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.