Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. Importantly, Pfizer Inc. (NYSE:PFE) does carry debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Pfizer

What Is Pfizer's Debt?

As you can see below, Pfizer had US$40.5b of debt, at July 2022, which is about the same as the year before. You can click the chart for greater detail. However, because it has a cash reserve of US$33.3b, its net debt is less, at about US$7.18b.

How Healthy Is Pfizer's Balance Sheet?

We can see from the most recent balance sheet that Pfizer had liabilities of US$47.4b falling due within a year, and liabilities of US$60.4b due beyond that. Offsetting this, it had US$33.3b in cash and US$17.7b in receivables that were due within 12 months. So it has liabilities totalling US$56.8b more than its cash and near-term receivables, combined.

Pfizer has a very large market capitalization of US$281.2b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Pfizer has a low net debt to EBITDA ratio of only 0.16. And its EBIT easily covers its interest expense, being 37.8 times the size. So we're pretty relaxed about its super-conservative use of debt. Even more impressive was the fact that Pfizer grew its EBIT by 162% over twelve months. That boost will make it even easier to pay down debt going forward. 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 Pfizer's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Pfizer 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.

Our View

The good news is that Pfizer's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And that's just the beginning of the good news since its conversion of EBIT to free cash flow is also very heartening. Considering this range of factors, it seems to us that Pfizer is quite prudent with its debt, and the risks seem well managed. So we're not worried about the use of a little leverage on the balance sheet. 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 example Pfizer has 2 warning signs (and 1 which doesn't sit too well with us) we think you should know about.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.