The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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 Greatoo Intelligent Equipment Inc. (SZSE:002031) does use debt in its business. But the real question is whether this debt is making the company risky.
When Is Debt A Problem?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.
How Much Debt Does Greatoo Intelligent Equipment Carry?
The image below, which you can click on for greater detail, shows that Greatoo Intelligent Equipment had debt of CN¥1.15b at the end of September 2023, a reduction from CN¥1.35b over a year. However, it also had CN¥139.0m in cash, and so its net debt is CN¥1.01b.
How Healthy Is Greatoo Intelligent Equipment's Balance Sheet?
The latest balance sheet data shows that Greatoo Intelligent Equipment had liabilities of CN¥1.10b due within a year, and liabilities of CN¥521.2m falling due after that. On the other hand, it had cash of CN¥139.0m and CN¥361.9m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥1.12b.
Since publicly traded Greatoo Intelligent Equipment shares are worth a total of CN¥7.28b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. There's no doubt that we learn most about debt from the balance sheet. But it is Greatoo Intelligent Equipment's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Over 12 months, Greatoo Intelligent Equipment made a loss at the EBIT level, and saw its revenue drop to CN¥781m, which is a fall of 41%. To be frank that doesn't bode well.
Caveat Emptor
Not only did Greatoo Intelligent Equipment's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost CN¥25m 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. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. However, it doesn't help that it burned through CN¥333m of cash over the last year. So suffice it to say we do consider the stock to be risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. We've identified 3 warning signs with Greatoo Intelligent Equipment (at least 2 which shouldn't be ignored) , and understanding them should be part of your investment process.
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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.