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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 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. We note that SailPoint Technologies Holdings, Inc. (NYSE:SAIL) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
When Is Debt A Problem?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is SailPoint Technologies Holdings's Debt?
The image below, which you can click on for greater detail, shows that at September 2020 SailPoint Technologies Holdings had debt of US$322.2m, up from US$304.8m in one year. But on the other hand it also has US$483.7m in cash, leading to a US$161.5m net cash position.
How Healthy Is SailPoint Technologies Holdings's Balance Sheet?
We can see from the most recent balance sheet that SailPoint Technologies Holdings had liabilities of US$509.8m falling due within a year, and liabilities of US$70.0m due beyond that. Offsetting these obligations, it had cash of US$483.7m as well as receivables valued at US$104.2m due within 12 months. So its total liabilities are just about perfectly matched by its shorter-term, liquid assets.
This state of affairs indicates that SailPoint Technologies Holdings's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the US$4.55b company is struggling for cash, we still think it's worth monitoring its balance sheet. Simply put, the fact that SailPoint Technologies Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.
We also note that SailPoint Technologies Holdings improved its EBIT from a last year's loss to a positive US$13m. 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 SailPoint Technologies Holdings'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.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While SailPoint Technologies 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 last year, SailPoint Technologies Holdings actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.
While it is always sensible to investigate a company's debt, in this case SailPoint Technologies Holdings has US$161.5m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 312% of that EBIT to free cash flow, bringing in US$41m. So we are not troubled with SailPoint Technologies Holdings's debt use. 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. Be aware that SailPoint Technologies Holdings is showing 3 warning signs in our investment analysis , and 1 of those doesn't sit too well with us...
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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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