Is Newland Digital TechnologyLtd (SZSE:000997) 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.' 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 note that Newland Digital Technology Co.,Ltd. (SZSE:000997) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Newland Digital TechnologyLtd

What Is Newland Digital TechnologyLtd's Debt?

The image below, which you can click on for greater detail, shows that Newland Digital TechnologyLtd had debt of CN¥1.23b at the end of September 2024, a reduction from CN¥1.35b over a year. But on the other hand it also has CN¥4.08b in cash, leading to a CN¥2.85b net cash position.

How Healthy Is Newland Digital TechnologyLtd's Balance Sheet?

The latest balance sheet data shows that Newland Digital TechnologyLtd had liabilities of CN¥5.09b due within a year, and liabilities of CN¥160.7m falling due after that. Offsetting this, it had CN¥4.08b in cash and CN¥2.12b in receivables that were due within 12 months. So it actually has CN¥952.5m more liquid assets than total liabilities.

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

On top of that, Newland Digital TechnologyLtd grew its EBIT by 42% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Newland Digital TechnologyLtd'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 business needs free cash flow to pay off debt; accounting profits just don't cut it. While Newland Digital TechnologyLtd 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. Happily for any shareholders, Newland Digital TechnologyLtd actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

While it is always sensible to investigate a company's debt, in this case Newland Digital TechnologyLtd has CN¥2.85b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 128% of that EBIT to free cash flow, bringing in CN¥628m. So we don't think Newland Digital TechnologyLtd's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 1 warning sign we've spotted with Newland Digital TechnologyLtd .

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.

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.