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. Importantly, Digital Value S.p.A. (BIT:DGV) does carry 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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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 step when considering a company's debt levels is to consider its cash and debt together.
Check out our latest analysis for Digital Value
What Is Digital Value's Net Debt?
The image below, which you can click on for greater detail, shows that at June 2021 Digital Value had debt of €25.6m, up from €15.6m in one year. However, its balance sheet shows it holds €55.9m in cash, so it actually has €30.3m net cash.
How Healthy Is Digital Value's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Digital Value had liabilities of €222.9m due within 12 months and liabilities of €33.3m due beyond that. Offsetting this, it had €55.9m in cash and €110.8m in receivables that were due within 12 months. So it has liabilities totalling €89.5m more than its cash and near-term receivables, combined.
Given Digital Value has a market capitalization of €954.1m, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, Digital Value 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 Digital Value has boosted its EBIT by 36%, 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 future earnings, more than anything, that will determine Digital Value'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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Digital Value may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. In the last three years, Digital Value's free cash flow amounted to 20% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.
Summing up
While it is always sensible to look at a company's total liabilities, it is very reassuring that Digital Value has €30.3m in net cash. And it impressed us with its EBIT growth of 36% over the last year. So we don't think Digital Value's use of debt is risky. Over time, share prices tend to follow earnings per share, so if you're interested in Digital Value, you may well want to click here to check an interactive graph of its earnings per share history.
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.
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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.
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About BIT:DGV
Outstanding track record, undervalued and pays a dividend.