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. As with many other companies Guizhou Zhenhua Fengguang Semiconductor Co., Ltd. (SHSE:688439) makes use of debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

How Much Debt Does Guizhou Zhenhua Fengguang Semiconductor Carry?

As you can see below, at the end of September 2024, Guizhou Zhenhua Fengguang Semiconductor had CN¥113.7m of debt, up from CN¥93.6m a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥2.19b in cash, so it actually has CN¥2.07b net cash.

How Strong Is Guizhou Zhenhua Fengguang Semiconductor's Balance Sheet?

We can see from the most recent balance sheet that Guizhou Zhenhua Fengguang Semiconductor had liabilities of CN¥510.3m falling due within a year, and liabilities of CN¥118.5m due beyond that. Offsetting these obligations, it had cash of CN¥2.19b as well as receivables valued at CN¥1.86b due within 12 months. So it can boast CN¥3.42b more liquid assets than total liabilities.

This luscious liquidity implies that Guizhou Zhenhua Fengguang Semiconductor's balance sheet is sturdy like a giant sequoia tree. With this in mind one could posit that its balance sheet means the company is able to handle some adversity. Simply put, the fact that Guizhou Zhenhua Fengguang Semiconductor has more cash than debt is arguably a good indication that it can manage its debt safely.

In fact Guizhou Zhenhua Fengguang Semiconductor's saving grace is its low debt levels, because its EBIT has tanked 20% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. 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 Guizhou Zhenhua Fengguang Semiconductor's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Guizhou Zhenhua Fengguang Semiconductor 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. During the last three years, Guizhou Zhenhua Fengguang Semiconductor 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 Guizhou Zhenhua Fengguang Semiconductor has CN¥2.07b in net cash and a decent-looking balance sheet. So we are not troubled with Guizhou Zhenhua Fengguang Semiconductor's debt use. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 3 warning signs for Guizhou Zhenhua Fengguang Semiconductor you should be aware of, and 1 of them is potentially serious.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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