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, Palm Eco-Town Development Co., Ltd (SZSE:002431) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. 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. 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 examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Palm Eco-Town Development

How Much Debt Does Palm Eco-Town Development Carry?

As you can see below, Palm Eco-Town Development had CN¥6.67b of debt, at September 2023, which is about the same as the year before. You can click the chart for greater detail. However, it does have CN¥568.2m in cash offsetting this, leading to net debt of about CN¥6.10b.

How Healthy Is Palm Eco-Town Development's Balance Sheet?

We can see from the most recent balance sheet that Palm Eco-Town Development had liabilities of CN¥14.5b falling due within a year, and liabilities of CN¥1.16b due beyond that. Offsetting this, it had CN¥568.2m in cash and CN¥10.2b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥4.89b.

Given this deficit is actually higher than the company's market capitalization of CN¥4.37b, we think shareholders really should watch Palm Eco-Town Development's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. When analysing debt levels, the balance sheet is the obvious place to start. But it is Palm Eco-Town Development'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.

In the last year Palm Eco-Town Development wasn't profitable at an EBIT level, but managed to grow its revenue by 54%, to CN¥4.8b. Shareholders probably have their fingers crossed that it can grow its way to profits.

Caveat Emptor

While we can certainly appreciate Palm Eco-Town Development's revenue growth, its earnings before interest and tax (EBIT) loss is not ideal. Indeed, it lost CN¥310m at the EBIT level. When we look at that alongside the significant liabilities, we're not particularly confident about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. It's fair to say the loss of CN¥602m didn't encourage us either; we'd like to see a profit. In the meantime, we consider the stock to be risky. 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Palm Eco-Town Development 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.