The direct benefit for DataDot Technology Limited (ASX:DDT), 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 DDT will have to adhere to stricter debt covenants and have less financial flexibility. While DDT has no debt on its balance sheet, it doesn’t necessarily mean it exhibits financial strength. I will take you through a few basic checks to assess the financial health of companies with no debt.
Want to help shape the future of investing tools and platforms? Take the survey and be part of one of the most advanced studies of stock market investors to date.
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. 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 DDT’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 DDT is a high-growth company. DDT delivered a negative revenue growth of -8.9%. 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 DDT’s liquid assets cover its short-term commitments?
Since DataDot Technology 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. At the current liabilities level of AU$1.1m, it appears that the company has been able to meet these obligations given the level of current assets of AU$2.7m, with a current ratio of 2.51x. For Auto Components companies, this ratio is within a sensible range since there’s a sufficient cash cushion without leaving too much capital idle or in low-earning investments.
Having no debt on the books means DDT has more financial freedom to keep growing at its current fast rate. This may mean this is an optimal capital structure for the business, given that it is also meeting its short-term commitment. Moving forward, its financial position may change. Keep in mind I haven’t considered other factors such as how DDT has been performing in the past. You should continue to research DataDot Technology to get a better picture of the stock by looking at:
- Historical Performance: What has DDT’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.
- 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 email@example.com.