Legendary fund manager Li Lu (who Charlie Munger backed) once said, ‘The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.’ So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Solomon Technology Corporation (TPE:2359) does carry debt. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
Generally speaking, debt only becomes a real problem when a company can’t easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can’t fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Solomon Technology’s Debt?
You can click the graphic below for the historical numbers, but it shows that as of September 2020 Solomon Technology had NT$293.0m of debt, an increase on none, over one year. However, its balance sheet shows it holds NT$2.65b in cash, so it actually has NT$2.36b net cash.
How Strong Is Solomon Technology’s Balance Sheet?
We can see from the most recent balance sheet that Solomon Technology had liabilities of NT$1.55b falling due within a year, and liabilities of NT$68.3m due beyond that. On the other hand, it had cash of NT$2.65b and NT$711.3m worth of receivables due within a year. So it actually has NT$1.74b more liquid assets than total liabilities.
This luscious liquidity implies that Solomon Technology’s balance sheet is sturdy like a giant sequoia tree. Having regard to this fact, we think its balance sheet is as strong as an ox. Succinctly put, Solomon Technology boasts net cash, so it’s fair to say it does not have a heavy debt load!
Fortunately, Solomon Technology grew its EBIT by 9.5% in the last year, making that debt load look even more manageable. When analysing debt levels, the balance sheet is the obvious place to start. But it is Solomon Technology’s earnings that will influence how the balance sheet holds up in the future. So when considering debt, it’s definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Solomon Technology has net cash on its balance sheet, it’s still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, Solomon Technology actually produced more free cash flow than EBIT. There’s nothing better than incoming cash when it comes to staying in your lenders’ good graces.
While it is always sensible to investigate a company’s debt, in this case Solomon Technology has NT$2.36b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 418% of that EBIT to free cash flow, bringing in NT$227m. The bottom line is that we do not find Solomon Technology’s debt levels at all concerning. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 4 warning signs we’ve spotted with Solomon Technology (including 1 which is potentially serious) .
If, after all that, you’re more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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