David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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, Applied Materials, Inc. (NASDAQ:AMAT) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

How Much Debt Does Applied Materials Carry?

You can click the graphic below for the historical numbers, but it shows that as of October 2024 Applied Materials had US$6.26b of debt, an increase on US$5.56b, over one year. But it also has US$9.47b in cash to offset that, meaning it has US$3.21b net cash.

How Healthy Is Applied Materials' Balance Sheet?

The latest balance sheet data shows that Applied Materials had liabilities of US$8.47b due within a year, and liabilities of US$6.94b falling due after that. On the other hand, it had cash of US$9.47b and US$5.23b worth of receivables due within a year. So its liabilities total US$703.0m more than the combination of its cash and short-term receivables.

This state of affairs indicates that Applied Materials' balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the US$144.2b company is short on cash, but still worth keeping an eye on the balance sheet. While it does have liabilities worth noting, Applied Materials also has more cash than debt, so we're pretty confident it can manage its debt safely.

Fortunately, Applied Materials grew its EBIT by 2.8% 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 ultimately the future profitability of the business will decide if Applied Materials can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Applied Materials 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. Over the last three years, Applied Materials recorded free cash flow worth a fulsome 84% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Applied Materials has US$3.21b in net cash. The cherry on top was that in converted 84% of that EBIT to free cash flow, bringing in US$7.5b. So we don't think Applied Materials's use of debt is risky. We'd be very excited to see if Applied Materials insiders have been snapping up shares. If you are too, then click on this link right now to take a (free) peek at our list of reported insider transactions.

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.