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Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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 Zovio Inc (NASDAQ:ZVO) does have debt on its balance sheet. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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 Zovio's Net Debt?
The image below, which you can click on for greater detail, shows that at September 2021 Zovio had debt of US$2.89m, up from US$2.76m in one year. However, its balance sheet shows it holds US$32.9m in cash, so it actually has US$30.0m net cash.
How Healthy Is Zovio's Balance Sheet?
The latest balance sheet data shows that Zovio had liabilities of US$71.0m due within a year, and liabilities of US$44.0m falling due after that. On the other hand, it had cash of US$32.9m and US$9.02m worth of receivables due within a year. So it has liabilities totalling US$73.0m more than its cash and near-term receivables, combined.
This deficit casts a shadow over the US$30.5m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Zovio would likely require a major re-capitalisation if it had to pay its creditors today. Zovio boasts net cash, so it's fair to say it does not have a heavy debt load, even if it does have very significant liabilities, in total. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Zovio 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.
Over 12 months, Zovio made a loss at the EBIT level, and saw its revenue drop to US$301m, which is a fall of 25%. To be frank that doesn't bode well.
So How Risky Is Zovio?
Statistically speaking companies that lose money are riskier than those that make money. And the fact is that over the last twelve months Zovio lost money at the earnings before interest and tax (EBIT) line. And over the same period it saw negative free cash outflow of US$8.7m and booked a US$76m accounting loss. Given it only has net cash of US$30.0m, the company may need to raise more capital if it doesn't reach break-even soon. Overall, we'd say the stock is a bit risky, and we're usually very cautious until we see positive free cash flow. 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. For instance, we've identified 5 warning signs for Zovio (2 are significant) you should be aware of.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.