Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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 The Western Investment Company of Canada Limited (CVE:WI) does use debt in its business. 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. 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. 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 Western Investment Company of Canada Carry?
As you can see below, at the end of March 2020, Western Investment Company of Canada had CA$4.18m of debt, up from CA$1.74m a year ago. Click the image for more detail. Net debt is about the same, since the it doesn't have much cash.
How Strong Is Western Investment Company of Canada's Balance Sheet?
The latest balance sheet data shows that Western Investment Company of Canada had liabilities of CA$95.6k due within a year, and liabilities of CA$4.17m falling due after that. Offsetting these obligations, it had cash of CA$1.1k as well as receivables valued at CA$351.5k due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CA$3.92m.
Western Investment Company of Canada has a market capitalization of CA$7.63m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. When analysing debt levels, the balance sheet is the obvious place to start. But it is Western Investment Company of Canada'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.
It seems likely shareholders hope that Western Investment Company of Canada can significantly advance the business plan before too long, because it doesn't have any significant revenue at the moment.
Over the last twelve months Western Investment Company of Canada produced an earnings before interest and tax (EBIT) loss. To be specific the EBIT loss came in at CA$144k. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. Another cause for caution is that is bled CA$502k in negative free cash flow over the last twelve months. So in short it's a really risky stock. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 3 warning signs we've spotted with Western Investment Company of Canada .
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. 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.
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