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. We can see that Gohigh Networks Co.,Ltd (SZSE:000851) does use debt in its business. But the real question is whether this debt is making the company risky.
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. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth 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 Gohigh NetworksLtd's Net Debt?
The image below, which you can click on for greater detail, shows that at September 2023 Gohigh NetworksLtd had debt of CN¥1.50b, up from CN¥1.34b in one year. However, because it has a cash reserve of CN¥940.3m, its net debt is less, at about CN¥560.3m.
A Look At Gohigh NetworksLtd's Liabilities
The latest balance sheet data shows that Gohigh NetworksLtd had liabilities of CN¥4.57b due within a year, and liabilities of CN¥350.9m falling due after that. On the other hand, it had cash of CN¥940.3m and CN¥2.99b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥994.3m.
This deficit isn't so bad because Gohigh NetworksLtd is worth CN¥4.97b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Gohigh NetworksLtd will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
In the last year Gohigh NetworksLtd's revenue was pretty flat, and it made a negative EBIT. While that's not too bad, we'd prefer see growth.
Caveat Emptor
Importantly, Gohigh NetworksLtd had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost CN¥6.3m at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. Another cause for caution is that is bled CN¥288m in negative free cash flow over the last twelve months. So in short it's a really risky stock. 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. For example Gohigh NetworksLtd has 2 warning signs (and 1 which is concerning) we think you should know about.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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