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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Everdisplay Optronics (Shanghai) Co., Ltd. (SHSE:688538) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is Everdisplay Optronics (Shanghai)'s Debt?

The image below, which you can click on for greater detail, shows that at March 2024 Everdisplay Optronics (Shanghai) had debt of CN¥14.6b, up from CN¥13.4b in one year. However, it does have CN¥2.06b in cash offsetting this, leading to net debt of about CN¥12.5b.

How Strong Is Everdisplay Optronics (Shanghai)'s Balance Sheet?

The latest balance sheet data shows that Everdisplay Optronics (Shanghai) had liabilities of CN¥3.27b due within a year, and liabilities of CN¥13.1b falling due after that. Offsetting these obligations, it had cash of CN¥2.06b as well as receivables valued at CN¥392.3m due within 12 months. So it has liabilities totalling CN¥13.9b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Everdisplay Optronics (Shanghai) has a market capitalization of CN¥28.4b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. When analysing debt levels, the balance sheet is the obvious place to start. But it is Everdisplay Optronics (Shanghai)'s earnings that will influence how the balance sheet holds up in the future. 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.

In the last year Everdisplay Optronics (Shanghai) had a loss before interest and tax, and actually shrunk its revenue by 18%, to CN¥3.3b. We would much prefer see growth.

Caveat Emptor

Not only did Everdisplay Optronics (Shanghai)'s revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost a very considerable CN¥2.9b at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. So we think its balance sheet is a little strained, though not beyond repair. However, it doesn't help that it burned through CN¥1.5b of cash over the last year. So in short it's a really risky stock. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Everdisplay Optronics (Shanghai) you should know about.

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