Is Amoy Diagnostics (SZSE:300685) A Risky Investment?

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Amoy Diagnostics Co., Ltd. (SZSE:300685) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

What Is Amoy Diagnostics's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2024 Amoy Diagnostics had debt of CN¥52.9m, up from CN¥50.2m in one year. However, its balance sheet shows it holds CN¥1.09b in cash, so it actually has CN¥1.03b net cash.

How Healthy Is Amoy Diagnostics' Balance Sheet?

We can see from the most recent balance sheet that Amoy Diagnostics had liabilities of CN¥216.3m falling due within a year, and liabilities of CN¥10.8m due beyond that. On the other hand, it had cash of CN¥1.09b and CN¥601.0m worth of receivables due within a year. So it can boast CN¥1.46b more liquid assets than total liabilities.

This excess liquidity suggests that Amoy Diagnostics is taking a careful approach to debt. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Simply put, the fact that Amoy Diagnostics has more cash than debt is arguably a good indication that it can manage its debt safely.

See our latest analysis for Amoy Diagnostics

On top of that, Amoy Diagnostics grew its EBIT by 67% over the last twelve months, and that growth will make it easier to handle its debt. 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 Amoy Diagnostics's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Amoy Diagnostics 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 last three years, Amoy Diagnostics recorded free cash flow worth a fulsome 86% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Summing Up

While it is always sensible to investigate a company's debt, in this case Amoy Diagnostics has CN¥1.03b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of CN¥289m, being 86% of its EBIT. The bottom line is that we do not find Amoy Diagnostics's debt levels at all concerning. Over time, share prices tend to follow earnings per share, so if you're interested in Amoy Diagnostics, you may well want to click here to check an interactive graph of its earnings per share history.

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.

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.