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.' 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. As with many other companies Caltagirone Editore SpA (BIT:CED) makes use of debt. But the real question is whether this debt is making the company risky.
Why Does Debt Bring Risk?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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. 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 Caltagirone Editore's Net Debt?
As you can see below, Caltagirone Editore had €7.91m of debt, at June 2019, which is about the same the year before. You can click the chart for greater detail. However, it does have €111.7m in cash offsetting this, leading to net cash of €103.8m.
A Look At Caltagirone Editore's Liabilities
According to the last reported balance sheet, Caltagirone Editore had liabilities of €56.9m due within 12 months, and liabilities of €81.6m due beyond 12 months. Offsetting this, it had €111.7m in cash and €42.1m in receivables that were due within 12 months. So it actually has €15.3m more liquid assets than total liabilities.
This short term liquidity is a sign that Caltagirone Editore could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Caltagirone Editore has more cash than debt is arguably a good indication that it can manage its debt safely. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Caltagirone Editore will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Over 12 months, Caltagirone Editore saw its revenue drop to €138m, which is a fall of 4.8%. We would much prefer see growth.
So How Risky Is Caltagirone Editore?
While Caltagirone Editore lost money on an earnings before interest and tax (EBIT) level, it actually generated positive free cash flow €3.5m. So taking that on face value, and considering the net cash situation, we don't think that the stock is too risky in the near term. We'll feel more comfortable with the stock once EBIT is positive, given the lacklustre revenue growth. When we look at a riskier company, we like to check how their profits (or losses) are trending over time. Today, we're providing readers this interactive graph showing how Caltagirone Editore's profit, revenue, and operating cashflow have changed over the last few years.
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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If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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. Simply Wall St has no position in the stocks mentioned. Thank you for reading.