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Warren Buffett famously said, '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. Importantly, Cognizant Technology Solutions Corporation (NASDAQ:CTSH) does carry debt. But is this debt a concern to shareholders?
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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.
How Much Debt Does Cognizant Technology Solutions Carry?
The image below, which you can click on for greater detail, shows that at September 2020 Cognizant Technology Solutions had debt of US$2.45b, up from US$747.0m in one year. But it also has US$4.58b in cash to offset that, meaning it has US$2.13b net cash.
How Healthy Is Cognizant Technology Solutions' Balance Sheet?
According to the last reported balance sheet, Cognizant Technology Solutions had liabilities of US$3.30b due within 12 months, and liabilities of US$4.35b due beyond 12 months. On the other hand, it had cash of US$4.58b and US$3.46b worth of receivables due within a year. So it actually has US$386.0m more liquid assets than total liabilities.
Having regard to Cognizant Technology Solutions' size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the US$43.8b company is struggling for cash, we still think it's worth monitoring its balance sheet. Succinctly put, Cognizant Technology Solutions boasts net cash, so it's fair to say it does not have a heavy debt load!
On the other hand, Cognizant Technology Solutions saw its EBIT drop by 5.3% in the last twelve months. That sort of decline, if sustained, will obviously make debt harder to handle. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Cognizant Technology Solutions 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.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Cognizant Technology Solutions 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. Over the last three years, Cognizant Technology Solutions recorded free cash flow worth a fulsome 88% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.
While it is always sensible to investigate a company's debt, in this case Cognizant Technology Solutions has US$2.13b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 88% of that EBIT to free cash flow, bringing in US$2.9b. So is Cognizant Technology Solutions's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Take risks, for example - Cognizant Technology Solutions has 1 warning sign we think 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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