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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Grown Up Group Investment Holdings Limited (HKG:1842) does have debt on its balance sheet. 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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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 step when considering a company's debt levels is to consider its cash and debt together.
What Is Grown Up Group Investment Holdings's Debt?
You can click the graphic below for the historical numbers, but it shows that Grown Up Group Investment Holdings had HK$72.8m of debt in June 2019, down from HK$82.9m, one year before. But on the other hand it also has HK$100.2m in cash, leading to a HK$27.4m net cash position.
How Strong Is Grown Up Group Investment Holdings's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Grown Up Group Investment Holdings had liabilities of HK$281.5m due within 12 months and liabilities of HK$18.3m due beyond that. Offsetting these obligations, it had cash of HK$100.2m as well as receivables valued at HK$160.6m due within 12 months. So it has liabilities totalling HK$39.0m more than its cash and near-term receivables, combined.
Of course, Grown Up Group Investment Holdings has a market capitalization of HK$440.0m, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, Grown Up Group Investment Holdings also has more cash than debt, so we're pretty confident it can manage its debt safely.
And we also note warmly that Grown Up Group Investment Holdings grew its EBIT by 10% last year, making its debt load easier to handle. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Grown Up Group Investment Holdings will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Grown Up Group Investment Holdings 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. Over the most recent three years, Grown Up Group Investment Holdings recorded free cash flow worth 67% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.
While it is always sensible to look at a company's total liabilities, it is very reassuring that Grown Up Group Investment Holdings has HK$27.4m in net cash. The cherry on top was that in converted 67% of that EBIT to free cash flow, bringing in HK$12m. So is Grown Up Group Investment Holdings's debt a risk? It doesn't seem so to us. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Grown Up Group Investment Holdings's earnings per share history for free.
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.
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If you spot an error that warrants correction, please contact the editor at email@example.com. 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.