Small-cap companies such as SORL Auto Parts Inc (NASDAQ:SORL) with its market cap of USD $62 Million, benefit the most from improving economic conditions due to the growth potential, but on the other hand they also are highly prone to a downturn, thus making their financial strength an important factor in filtering out the risky ones. Although SORL’s low debt-to-equity ratio of 16.3% indicates financial strength, there’s more to it than just one ratio.
Primarily due to the lack of diversification in revenues geographically, often investors opt for a bundle of small-caps. On the other hand, well-versed investors allocate a small part of their portfolio capital to individual small-caps, primarily to improve its risk-return profile. However, that doesn’t reduce the risks these companies face individually. But I believe that it can be reduced to some extent by looking at these back of the hand balance sheet calculations. See our latest analysis for SORL
Does SORL Auto Parts generate enough cash through operations to meet all its needs?
Apart from a low-debt load, another highly important financial-check is whether the company can cover its operating expenses and generate enough cash to fund growth after paying interest on its debt. Strong, and positive, operating cash flow indicates that the company is profitable in its core activity. However, if the company is growing exceptionally fast, it’s acceptable that it depends on external sources of funding even to operate. If a company’s operating cash flows are more than 20% of its overall debt, it’s considered financially strong as it generates enough surplus cash. However, on this front, SORL Auto Parts fails to impress with an operating cash flow to the overall debt ratio of just 15.4%. So, while it covers its operating expenses, it may not be generating enough cash to return to shareholders or fund its expansion after servicing its debt obligations.
Does SORL nets enough to cover its debt-costs?
While operating cash flows are vital, earnings tell how profitable is the company, after also accounting for its gains and losses in non-core ventures and non-cash expenses such as depreciation and amortization. When a company earns enough to service its debt comfortably, this reflects its profitability and financial strength . A ratio of earnings versus interest payments above 5x is an indication of strong financial position. In SORL’s case the company earns more interest than it pays.
SORL Auto Parts fails to impress in terms of its operating cash flows compared to its overall-debt. However, the company does well on the earnings to interest-costs ratio. It appears SORL needs to increase the operational efficiency to be categorized as a financially healthy company. Now when you know whether you should keep the debt in mind as a risk factor when putting together your investment thesis, I recommend you check out our latest free analysis report on SORL Auto Parts to see what are SORL’s growth prospects and whether it could be considered an undervalued opportunity.
PS. If you are not interested in SORL Auto Parts anymore, you can use our free platform to see my list of over 150 other stocks with a high growth potential.