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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Digital Domain Holdings Limited (HKG:547) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest 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 Digital Domain Holdings's Net Debt?

The chart below, which you can click on for greater detail, shows that Digital Domain Holdings had HK$350.7m in debt in December 2023; about the same as the year before. However, it does have HK$464.7m in cash offsetting this, leading to net cash of HK$114.0m.

A Look At Digital Domain Holdings' Liabilities

We can see from the most recent balance sheet that Digital Domain Holdings had liabilities of HK$397.9m falling due within a year, and liabilities of HK$348.7m due beyond that. On the other hand, it had cash of HK$464.7m and HK$70.8m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$211.1m.

Since publicly traded Digital Domain Holdings shares are worth a total of HK$2.39b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, Digital Domain Holdings also has more cash than debt, so we're pretty confident it can manage its debt safely. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Digital Domain Holdings 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, Digital Domain Holdings made a loss at the EBIT level, and saw its revenue drop to HK$737m, which is a fall of 23%. That makes us nervous, to say the least.

So How Risky Is Digital Domain Holdings?

By their very nature companies that are losing money are more risky than those with a long history of profitability. And the fact is that over the last twelve months Digital Domain Holdings lost money at the earnings before interest and tax (EBIT) line. Indeed, in that time it burnt through HK$170m of cash and made a loss of HK$395m. But the saving grace is the HK$114.0m on the balance sheet. That kitty means the company can keep spending for growth for at least two years, at current rates. Overall, we'd say the stock is a bit risky, and we're usually very cautious until we see positive free cash flow. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 3 warning signs for Digital Domain Holdings (1 is significant) you should be aware of.

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.

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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