DWS Limited (ASX:DWS) is a small-cap stock with a market capitalization of AU$179.29M. While investors primarily focus on the growth potential and competitive landscape of the small-cap companies, they end up ignoring a key aspect, which could be the biggest threat to its existence: its financial health. Why is it important? IT companies, even ones that are profitable, are more likely to be higher risk. Evaluating financial health as part of your investment thesis is vital. Here are a few basic checks that are good enough to have a broad overview of the company’s financial strength. Though, I know these factors are very high-level, so I recommend you dig deeper yourself into DWS here.
How does DWS’s operating cash flow stack up against its debt?
DWS’s debt levels have fallen from AU$24.00M to AU$15.00M over the last 12 months – this includes both the current and long-term debt. With this debt repayment, DWS currently has AU$10.87M remaining in cash and short-term investments for investing into the business. Moreover, DWS has generated cash from operations of AU$23.89M in the last twelve months, resulting in an operating cash to total debt ratio of 159.24%, signalling that DWS’s current level of operating cash is high enough to cover debt. This ratio can also be a sign of operational efficiency as an alternative to return on assets. In DWS’s case, it is able to generate 1.59x cash from its debt capital.
Can DWS meet its short-term obligations with the cash in hand?
Looking at DWS’s most recent AU$21.24M liabilities, it seems that the business has been able to meet these commitments with a current assets level of AU$35.01M, leading to a 1.65x current account ratio. Usually, for IT companies, this is a suitable ratio since there’s sufficient cash cushion without leaving too much capital idle or in low-earning investments.
Does DWS face the risk of succumbing to its debt-load?
With debt at 16.45% of equity, DWS may be thought of as appropriately levered. This range is considered safe as DWS is not taking on too much debt obligation, which may be constraining for future growth. We can test if DWS’s debt levels are sustainable by measuring interest payments against earnings of a company. Ideally, earnings before interest and tax (EBIT) should cover net interest by at least three times. For DWS, the ratio of 78.83x suggests that interest is comfortably covered, which means that debtors may be willing to loan the company more money, giving DWS ample headroom to grow its debt facilities.