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Is Diodes (NASDAQ:DIOD) A Risky Investment?

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Simply Wall St
·4 min read
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David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 Diodes Incorporated (NASDAQ:DIOD) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Diodes

What Is Diodes's Net Debt?

As you can see below, at the end of September 2020, Diodes had US$418.6m of debt, up from US$137.0m a year ago. Click the image for more detail. But it also has US$590.7m in cash to offset that, meaning it has US$172.1m net cash.

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

How Healthy Is Diodes' Balance Sheet?

We can see from the most recent balance sheet that Diodes had liabilities of US$321.5m falling due within a year, and liabilities of US$460.1m due beyond that. Offsetting these obligations, it had cash of US$590.7m as well as receivables valued at US$261.8m due within 12 months. So it can boast US$70.8m more liquid assets than total liabilities.

Having regard to Diodes' size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the US$4.15b company is short on cash, but still worth keeping an eye on the balance sheet. Succinctly put, Diodes boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for Diodes if management cannot prevent a repeat of the 28% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Diodes's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Diodes 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, Diodes produced sturdy free cash flow equating to 78% 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 we empathize with investors who find debt concerning, you should keep in mind that Diodes has net cash of US$172.1m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of US$108m, being 78% of its EBIT. So we are not troubled with Diodes's debt use. 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. To that end, you should be aware of the 3 warning signs we've spotted with Diodes .

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.

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