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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. Importantly, Nova Measuring Instruments Ltd. (NASDAQ:NVMI) does carry debt. But the real question is whether this debt is making the company risky.
When Is Debt Dangerous?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.
What Is Nova Measuring Instruments's Net Debt?
The image below, which you can click on for greater detail, shows that at December 2020 Nova Measuring Instruments had debt of US$178.8m, up from none in one year. However, its balance sheet shows it holds US$423.9m in cash, so it actually has US$245.1m net cash.
A Look At Nova Measuring Instruments' Liabilities
The latest balance sheet data shows that Nova Measuring Instruments had liabilities of US$60.9m due within a year, and liabilities of US$223.3m falling due after that. On the other hand, it had cash of US$423.9m and US$63.3m worth of receivables due within a year. So it actually has US$202.9m more liquid assets than total liabilities.
This short term liquidity is a sign that Nova Measuring Instruments could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Nova Measuring Instruments boasts net cash, so it's fair to say it does not have a heavy debt load!
On top of that, Nova Measuring Instruments grew its EBIT by 52% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Nova Measuring Instruments 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.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. Nova Measuring Instruments 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, Nova Measuring Instruments produced sturdy free cash flow equating to 70% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.
While it is always sensible to investigate a company's debt, in this case Nova Measuring Instruments has US$245.1m in net cash and a decent-looking balance sheet. And we liked the look of last year's 52% year-on-year EBIT growth. So we don't think Nova Measuring Instruments's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 2 warning signs for Nova Measuring Instruments 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.
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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