Zero-debt allows substantial financial flexibility, especially for small-cap companies like Power Integrations Inc (NASDAQ:POWI), 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 POWI has outstanding financial strength. I will take you through a few basic checks to assess the financial health of companies with no debt.
Is POWI right in choosing financial flexibility over lower cost of capital?
Debt capital generally has lower cost of capital compared to equity funding. 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 POWI’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 POWI is a high-growth company. POWI’s revenue growth over the past year is a single-digit 3.8% which is relatively low for a small-cap company. More capital can help the business grow faster. If POWI is not expecting exceptional future growth, then the decision to avoid may cost shareholders in the long term.
Can POWI meet its short-term obligations with the cash in hand?
Given zero long-term debt on its balance sheet, Power Integrations has no solvency issues, which is 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. Looking at POWI’s most recent US$44m liabilities, the company has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 7.5x. Having said that, many consider anything above 3x to be quite high and could mean that POWI has too much idle capital in low-earning investments.
POWI 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 POWI’s liquidity needs, this may be its optimal capital structure for the time being. Going forward, POWI’s financial situation may change. Keep in mind I haven’t considered other factors such as how POWI has been performing in the past. You should continue to research Power Integrations to get a more holistic view of the stock by looking at:
- Future Outlook: What are well-informed industry analysts predicting for POWI’s future growth? Take a look at our free research report of analyst consensus for POWI’s outlook.
- Valuation: What is POWI 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 POWI 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.