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, Donegal Investment Group plc (ISE:DQ7A) does carry debt. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Donegal Investment Group's Net Debt?
You can click the graphic below for the historical numbers, but it shows that Donegal Investment Group had €4.41m of debt in August 2019, down from €6.66m, one year before. However, it does have €25.7m in cash offsetting this, leading to net cash of €21.3m.
A Look At Donegal Investment Group's Liabilities
Zooming in on the latest balance sheet data, we can see that Donegal Investment Group had liabilities of €13.5m due within 12 months and liabilities of €341.0k due beyond that. Offsetting these obligations, it had cash of €25.7m as well as receivables valued at €5.87m due within 12 months. So it actually has €17.8m more liquid assets than total liabilities.
This surplus strongly suggests that Donegal Investment Group has a rock-solid balance sheet (and the debt is of no concern whatsoever). On this basis we think its balance sheet is strong like a sleek panther or even a proud lion. Simply put, the fact that Donegal Investment Group has more cash than debt is arguably a good indication that it can manage its debt safely.
In addition to that, we're happy to report that Donegal Investment Group has boosted its EBIT by 75%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Donegal Investment Group 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.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Donegal Investment Group has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Donegal Investment Group produced sturdy free cash flow equating to 74% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.
While we empathize with investors who find debt concerning, you should keep in mind that Donegal Investment Group has net cash of €21.3m, as well as more liquid assets than liabilities. And we liked the look of last year's 75% year-on-year EBIT growth. When it comes to Donegal Investment Group's debt, we sufficiently relaxed that our mind turns to the jacuzzi. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Take risks, for example - Donegal Investment Group has 2 warning signs 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.
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.
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