The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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, POCO Holding Co., Ltd. (SZSE:300811) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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. When we think about a company's use of debt, we first look at cash and debt together.

What Is POCO Holding's Net Debt?

As you can see below, POCO Holding had CN¥153.6m of debt at March 2024, down from CN¥201.7m a year prior. However, its balance sheet shows it holds CN¥265.6m in cash, so it actually has CN¥112.0m net cash.

How Strong Is POCO Holding's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that POCO Holding had liabilities of CN¥285.6m due within 12 months and liabilities of CN¥325.0m due beyond that. On the other hand, it had cash of CN¥265.6m and CN¥706.3m worth of receivables due within a year. So it actually has CN¥361.3m more liquid assets than total liabilities.

This surplus suggests that POCO Holding has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, POCO Holding boasts net cash, so it's fair to say it does not have a heavy debt load!

Fortunately, POCO Holding grew its EBIT by 5.3% in the last year, making that debt load look even more manageable. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine POCO Holding's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. POCO Holding may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, POCO Holding burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

While it is always sensible to investigate a company's debt, in this case POCO Holding has CN¥112.0m in net cash and a decent-looking balance sheet. And it also grew its EBIT by 5.3% over the last year. So we are not troubled with POCO Holding's debt use. Over time, share prices tend to follow earnings per share, so if you're interested in POCO Holding, you may well want to click here to check an interactive graph of its earnings per share history.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com