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 Hanma Technology Group Co.,Ltd. (SHSE:600375) makes use of debt. But the real question is whether this debt is making the company risky.

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 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, 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.

What Is Hanma Technology GroupLtd's Debt?

The image below, which you can click on for greater detail, shows that at September 2023 Hanma Technology GroupLtd had debt of CN¥4.70b, up from CN¥4.10b in one year. However, it does have CN¥1.33b in cash offsetting this, leading to net debt of about CN¥3.37b.

How Healthy Is Hanma Technology GroupLtd's Balance Sheet?

We can see from the most recent balance sheet that Hanma Technology GroupLtd had liabilities of CN¥6.98b falling due within a year, and liabilities of CN¥1.72b due beyond that. On the other hand, it had cash of CN¥1.33b and CN¥2.80b worth of receivables due within a year. So its liabilities total CN¥4.58b more than the combination of its cash and short-term receivables.

Given this deficit is actually higher than the company's market capitalization of CN¥3.80b, we think shareholders really should watch Hanma Technology GroupLtd's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Hanma Technology GroupLtd will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Over 12 months, Hanma Technology GroupLtd reported revenue of CN¥3.7b, which is a gain of 15%, although it did not report any earnings before interest and tax. That rate of growth is a bit slow for our taste, but it takes all types to make a world.

Caveat Emptor

Importantly, Hanma Technology GroupLtd had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost a very considerable CN¥658m at the EBIT level. When we look at that alongside the significant liabilities, we're not particularly confident about the company. It would need to improve its operations quickly for us to be interested in it. For example, we would not want to see a repeat of last year's loss of CN¥523m. In the meantime, we consider the stock to be risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Be aware that Hanma Technology GroupLtd is showing 2 warning signs in our investment analysis , you should know about...

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.