Is Shenzhen Fortune Trend technology (SHSE:688318) 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. As with many other companies Shenzhen Fortune Trend technology Co., Ltd. (SHSE:688318) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. 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. 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.

View our latest analysis for Shenzhen Fortune Trend technology

What Is Shenzhen Fortune Trend technology's Debt?

The image below, which you can click on for greater detail, shows that at March 2024 Shenzhen Fortune Trend technology had debt of CN¥120.0m, up from none in one year. But on the other hand it also has CN¥1.99b in cash, leading to a CN¥1.87b net cash position.

How Healthy Is Shenzhen Fortune Trend technology's Balance Sheet?

We can see from the most recent balance sheet that Shenzhen Fortune Trend technology had liabilities of CN¥262.6m falling due within a year, and liabilities of CN¥6.90m due beyond that. On the other hand, it had cash of CN¥1.99b and CN¥48.9m worth of receivables due within a year. So it can boast CN¥1.76b more liquid assets than total liabilities.

This short term liquidity is a sign that Shenzhen Fortune Trend technology could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Shenzhen Fortune Trend technology has more cash than debt is arguably a good indication that it can manage its debt safely.

In addition to that, we're happy to report that Shenzhen Fortune Trend technology has boosted its EBIT by 47%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Shenzhen Fortune Trend technology can strengthen its balance sheet over time. 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 Shenzhen Fortune Trend technology 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. During the last three years, Shenzhen Fortune Trend technology generated free cash flow amounting to a very robust 89% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Shenzhen Fortune Trend technology has net cash of CN¥1.87b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of CN¥176m, being 89% of its EBIT. So is Shenzhen Fortune Trend technology's debt a risk? It doesn't seem so to us. 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. For example, we've discovered 1 warning sign for Shenzhen Fortune Trend technology that you should be aware of before investing here.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com