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 Shanghai Electric Wind Power Group Co., Ltd. (SHSE:688660) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. 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.

How Much Debt Does Shanghai Electric Wind Power Group Carry?

As you can see below, at the end of September 2023, Shanghai Electric Wind Power Group had CN¥3.92b of debt, up from CN¥2.80b a year ago. Click the image for more detail. However, because it has a cash reserve of CN¥3.31b, its net debt is less, at about CN¥608.5m.

How Strong Is Shanghai Electric Wind Power Group's Balance Sheet?

We can see from the most recent balance sheet that Shanghai Electric Wind Power Group had liabilities of CN¥18.3b falling due within a year, and liabilities of CN¥6.12b due beyond that. On the other hand, it had cash of CN¥3.31b and CN¥9.89b worth of receivables due within a year. So its liabilities total CN¥11.3b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the CN¥5.01b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Shanghai Electric Wind Power Group would probably need a major re-capitalization if its creditors were to demand repayment. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Shanghai Electric Wind Power Group will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year Shanghai Electric Wind Power Group had a loss before interest and tax, and actually shrunk its revenue by 16%, to CN¥10b. That's not what we would hope to see.

Caveat Emptor

Not only did Shanghai Electric Wind Power Group's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost a very considerable CN¥1.4b 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. Not least because it burned through CN¥1.6b in negative free cash flow over the last year. So suffice it to say we consider the stock to be risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Shanghai Electric Wind Power Group is showing 1 warning sign in our investment analysis , you should know about...

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.