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, Digital Ally, Inc. (NASDAQ:DGLY) does carry debt. 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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Digital Ally's Debt?
The image below, which you can click on for greater detail, shows that Digital Ally had debt of US$5.18m at the end of June 2020, a reduction from US$6.24m over a year. But it also has US$16.2m in cash to offset that, meaning it has US$11.0m net cash.
How Healthy Is Digital Ally's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Digital Ally had liabilities of US$8.34m due within 12 months and liabilities of US$3.33m due beyond that. Offsetting these obligations, it had cash of US$16.2m as well as receivables valued at US$1.66m due within 12 months. So it actually has US$6.16m more liquid assets than total liabilities.
This surplus suggests that Digital Ally has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Digital Ally boasts net cash, so it's fair to say it does not have a heavy debt load! The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Digital Ally 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.
In the last year Digital Ally had a loss before interest and tax, and actually shrunk its revenue by 8.2%, to US$9.5m. That's not what we would hope to see.
So How Risky Is Digital Ally?
We have no doubt that loss making companies are, in general, riskier than profitable ones. And the fact is that over the last twelve months Digital Ally lost money at the earnings before interest and tax (EBIT) line. And over the same period it saw negative free cash outflow of US$6.8m and booked a US$9.2m accounting loss. With only US$11.0m on the balance sheet, it would appear that its going to need to raise capital again soon. Even though its balance sheet seems sufficiently liquid, debt always makes us a little nervous if a company doesn't produce free cash flow regularly. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Digital Ally is showing 4 warning signs in our investment analysis , and 1 of those is significant...
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.
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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