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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. It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Adobe Inc. (NASDAQ:ADBE) does have debt on its balance sheet. But is this debt a concern to shareholders?
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 step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does Adobe Carry?
The chart below, which you can click on for greater detail, shows that Adobe had US$4.11b in debt in May 2020; about the same as the year before. However, its balance sheet shows it holds US$4.35b in cash, so it actually has US$237.0m net cash.
A Look At Adobe's Liabilities
The latest balance sheet data shows that Adobe had liabilities of US$5.16b due within a year, and liabilities of US$5.56b falling due after that. On the other hand, it had cash of US$4.35b and US$1.37b worth of receivables due within a year. So it has liabilities totalling US$5.0b more than its cash and near-term receivables, combined.
Since publicly traded Adobe shares are worth a very impressive total of US$223.6b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, Adobe boasts net cash, so it's fair to say it does not have a heavy debt load!
In addition to that, we're happy to report that Adobe has boosted its EBIT by 31%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Adobe can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Adobe has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Happily for any shareholders, Adobe actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.
While it is always sensible to look at a company's total liabilities, it is very reassuring that Adobe has US$237.0m in net cash. The cherry on top was that in converted 125% of that EBIT to free cash flow, bringing in US$4.4b. So is Adobe's debt a risk? It doesn't seem so to us. 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. For instance, we've identified 2 warning signs for Adobe that you should be aware of.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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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