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Applied Materials (NASDAQ:AMAT) Has A Rock Solid Balance Sheet

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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.' 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. Importantly, Applied Materials, Inc. (NASDAQ:AMAT) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Applied Materials

How Much Debt Does Applied Materials Carry?

As you can see below, Applied Materials had US$5.45b of debt, at January 2022, which is about the same as the year before. You can click the chart for greater detail. However, it does have US$5.74b in cash offsetting this, leading to net cash of US$283.0m.

debt-equity-history-analysis
debt-equity-history-analysis

A Look At Applied Materials' Liabilities

Zooming in on the latest balance sheet data, we can see that Applied Materials had liabilities of US$6.26b due within 12 months and liabilities of US$7.27b due beyond that. Offsetting this, it had US$5.74b in cash and US$4.58b in receivables that were due within 12 months. So its liabilities total US$3.22b more than the combination of its cash and short-term receivables.

Since publicly traded Applied Materials shares are worth a very impressive total of US$115.3b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Applied Materials also has more cash than debt, so we're pretty confident it can manage its debt safely.

In addition to that, we're happy to report that Applied Materials has boosted its EBIT by 59%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Applied Materials's ability to maintain a healthy balance sheet going forward. 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. Applied Materials 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. During the last three years, Applied Materials produced sturdy free cash flow equating to 79% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Applied Materials has US$283.0m in net cash. And it impressed us with its EBIT growth of 59% over the last year. So is Applied Materials's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 1 warning sign with Applied Materials , and understanding them should be part of your investment process.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.