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 can see that Costar Group Co., Ltd. (SZSE:002189) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Costar Group

What Is Costar Group's Debt?

The image below, which you can click on for greater detail, shows that Costar Group had debt of CN¥608.0m at the end of September 2022, a reduction from CN¥647.4m over a year. However, it does have CN¥492.6m in cash offsetting this, leading to net debt of about CN¥115.4m.

How Healthy Is Costar Group's Balance Sheet?

The latest balance sheet data shows that Costar Group had liabilities of CN¥1.62b due within a year, and liabilities of CN¥268.8m falling due after that. On the other hand, it had cash of CN¥492.6m and CN¥1.35b worth of receivables due within a year. So its liabilities total CN¥49.3m more than the combination of its cash and short-term receivables.

This state of affairs indicates that Costar Group'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 CN¥4.44b company is struggling for cash, we still think it's worth monitoring its balance sheet. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Costar Group's earnings that will influence how the balance sheet holds up in the future. 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.

Over 12 months, Costar Group made a loss at the EBIT level, and saw its revenue drop to CN¥3.6b, which is a fall of 8.0%. That's not what we would hope to see.

Caveat Emptor

Importantly, Costar Group had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost CN¥4.0m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. So we think its balance sheet is a little strained, though not beyond repair. On the bright side, we note that trailing twelve month EBIT is worse than the free cash flow of CN¥154m and the profit of CN¥16m. So if we focus on those metrics there seems to be a chance the company will manage its debt without much trouble. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 3 warning signs for Costar Group that you should be aware of before investing here.

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.

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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.