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 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. We note that ShockWave Medical, Inc. (NASDAQ:SWAV) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. 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. When we think about a company's use of debt, we first look at cash and debt together.
See our latest analysis for ShockWave Medical
What Is ShockWave Medical's Net Debt?
You can click the graphic below for the historical numbers, but it shows that ShockWave Medical had US$14.9m of debt in September 2022, down from US$17.0m, one year before. However, its balance sheet shows it holds US$250.7m in cash, so it actually has US$235.8m net cash.
A Look At ShockWave Medical's Liabilities
The latest balance sheet data shows that ShockWave Medical had liabilities of US$54.2m due within a year, and liabilities of US$65.7m falling due after that. Offsetting these obligations, it had cash of US$250.7m as well as receivables valued at US$64.2m due within 12 months. So it can boast US$195.0m more liquid assets than total liabilities.
This surplus suggests that ShockWave Medical has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, ShockWave Medical boasts net cash, so it's fair to say it does not have a heavy debt load!
Although ShockWave Medical made a loss at the EBIT level, last year, it was also good to see that it generated US$96m in EBIT over the last twelve months. 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 ShockWave Medical'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. While ShockWave Medical 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 most recent year, ShockWave Medical recorded free cash flow worth 72% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.
Summing Up
While it is always sensible to investigate a company's debt, in this case ShockWave Medical has US$235.8m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 72% of that EBIT to free cash flow, bringing in US$69m. So is ShockWave Medical's debt a risk? It doesn't seem so to us. 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. We've identified 2 warning signs with ShockWave Medical (at least 1 which is a bit concerning) , and understanding them should be part of your investment process.
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.