Is Shanghai Stonehill Technology (SZSE:002195) A Risky Investment?

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.' 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 Shanghai Stonehill Technology Co., Ltd. (SZSE:002195) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. 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 think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Shanghai Stonehill Technology

What Is Shanghai Stonehill Technology's Debt?

The image below, which you can click on for greater detail, shows that Shanghai Stonehill Technology had debt of CN¥47.0m at the end of September 2023, a reduction from CN¥208.4m over a year. But it also has CN¥7.25b in cash to offset that, meaning it has CN¥7.21b net cash.

How Strong Is Shanghai Stonehill Technology's Balance Sheet?

According to the last reported balance sheet, Shanghai Stonehill Technology had liabilities of CN¥262.9m due within 12 months, and liabilities of CN¥43.5m due beyond 12 months. On the other hand, it had cash of CN¥7.25b and CN¥341.4m worth of receivables due within a year. So it actually has CN¥7.29b more liquid assets than total liabilities.

This surplus strongly suggests that Shanghai Stonehill Technology has a rock-solid balance sheet (and the debt is of no concern whatsoever). Having regard to this fact, we think its balance sheet is as strong as an ox. Succinctly put, Shanghai Stonehill Technology boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact Shanghai Stonehill Technology's saving grace is its low debt levels, because its EBIT has tanked 86% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. There's no doubt that we learn most about debt from the balance sheet. But it is Shanghai Stonehill Technology's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Shanghai Stonehill 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. Over the last three years, Shanghai Stonehill Technology actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Shanghai Stonehill Technology has net cash of CN¥7.21b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of CN¥313m, being 205% of its EBIT. So is Shanghai Stonehill Technology's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 4 warning signs for Shanghai Stonehill Technology (of which 1 is concerning!) you should know about.

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.

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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.