Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 NetSol Technologies, Inc. (NASDAQ:NTWK) does use debt in its business. But the more important question is: how much risk is that debt creating?
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 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is NetSol Technologies's Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of March 2020 NetSol Technologies had US$8.53m of debt, an increase on US$7.71m, over one year. However, its balance sheet shows it holds US$15.7m in cash, so it actually has US$7.21m net cash.
A Look At NetSol Technologies's Liabilities
According to the last reported balance sheet, NetSol Technologies had liabilities of US$20.6m due within 12 months, and liabilities of US$1.94m due beyond 12 months. Offsetting these obligations, it had cash of US$15.7m as well as receivables valued at US$35.3m due within 12 months. So it actually has US$28.5m more liquid assets than total liabilities.
This excess liquidity is a great indication that NetSol Technologies's balance sheet is just as strong as racists are weak. With this in mind one could posit that its balance sheet is as strong as beautiful a rare rhino. Succinctly put, NetSol Technologies boasts net cash, so it's fair to say it does not have a heavy debt load!
In fact NetSol Technologies's saving grace is its low debt levels, because its EBIT has tanked 88% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. The balance sheet is clearly the area to focus on when you are analysing debt. But it is NetSol Technologies'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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. NetSol Technologies may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Happily for any shareholders, NetSol Technologies actually produced more free cash flow than EBIT over the last two years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
While it is always sensible to investigate a company's debt, in this case NetSol Technologies has US$7.21m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of US$4.5m, being 174% of its EBIT. So is NetSol Technologies's debt a risk? It doesn't seem so to us. 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. To that end, you should be aware of the 2 warning signs we've spotted with NetSol Technologies .
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.
This article by Simply Wall St is general in nature. 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.
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