China Display Optoelectronics Technology Holdings (HKG:334) Has A Rock Solid Balance Sheet

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that China Display Optoelectronics Technology Holdings Limited (HKG:334) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for China Display Optoelectronics Technology Holdings

How Much Debt Does China Display Optoelectronics Technology Holdings Carry?

You can click the graphic below for the historical numbers, but it shows that China Display Optoelectronics Technology Holdings had CN¥87.3m of debt in June 2022, down from CN¥169.3m, one year before. But it also has CN¥1.03b in cash to offset that, meaning it has CN¥947.6m net cash.

How Healthy Is China Display Optoelectronics Technology Holdings' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that China Display Optoelectronics Technology Holdings had liabilities of CN¥1.69b due within 12 months and liabilities of CN¥41.0m due beyond that. Offsetting these obligations, it had cash of CN¥1.03b as well as receivables valued at CN¥884.1m due within 12 months. So it actually has CN¥192.7m more liquid assets than total liabilities.

This surplus suggests that China Display Optoelectronics Technology Holdings is using debt in a way that is appears to be both safe and conservative. Due to its strong net asset position, it is not likely to face issues with its lenders. Succinctly put, China Display Optoelectronics Technology Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

In addition to that, we're happy to report that China Display Optoelectronics Technology Holdings has boosted its EBIT by 73%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But it is China Display Optoelectronics Technology Holdings'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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While China Display Optoelectronics Technology Holdings 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, China Display Optoelectronics Technology Holdings actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that China Display Optoelectronics Technology Holdings has net cash of CN¥947.6m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of CN¥21m, being 326% of its EBIT. When it comes to China Display Optoelectronics Technology Holdings's debt, we sufficiently relaxed that our mind turns to the jacuzzi. The balance sheet is clearly the area to focus on when you are analysing debt. 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 1 warning sign for China Display Optoelectronics Technology Holdings 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.