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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 can see that Neuronetics, Inc. (NASDAQ:STIM) does use debt in its business. But the more important question is: how much risk is that debt creating?
When Is Debt A Problem?
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. When we think about a company's use of debt, we first look at cash and debt together.
What Is Neuronetics's Net Debt?
The image below, which you can click on for greater detail, shows that at June 2020 Neuronetics had debt of US$34.4m, up from US$30.8m in one year. However, it does have US$54.0m in cash offsetting this, leading to net cash of US$19.6m.
How Strong Is Neuronetics's Balance Sheet?
We can see from the most recent balance sheet that Neuronetics had liabilities of US$45.3m falling due within a year, and liabilities of US$5.21m due beyond that. On the other hand, it had cash of US$54.0m and US$7.94m worth of receivables due within a year. So it can boast US$11.4m more liquid assets than total liabilities.
This short term liquidity is a sign that Neuronetics could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Neuronetics boasts net cash, so it's fair to say it does not have a heavy debt load! There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Neuronetics can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
In the last year Neuronetics had a loss before interest and tax, and actually shrunk its revenue by 7.0%, to US$55m. That's not what we would hope to see.
So How Risky Is Neuronetics?
By their very nature companies that are losing money are more risky than those with a long history of profitability. And the fact is that over the last twelve months Neuronetics lost money at the earnings before interest and tax (EBIT) line. And over the same period it saw negative free cash outflow of US$38m and booked a US$35m accounting loss. But at least it has US$19.6m on the balance sheet to spend on growth, near-term. 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. However, not all investment risk resides within the balance sheet - far from it. Consider for instance, the ever-present spectre of investment risk. We've identified 3 warning signs with Neuronetics , and understanding them should be part of your investment process.
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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