Is Digital Holdings (TSE:2389) A Risky Investment?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. As with many other companies Digital Holdings, Inc. (TSE:2389) makes use of debt. But is this debt a concern to shareholders?

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When Is Debt Dangerous?

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. 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. 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.

How Much Debt Does Digital Holdings Carry?

As you can see below, Digital Holdings had JP¥4.08b of debt at December 2024, down from JP¥5.00b a year prior. However, it does have JP¥21.7b in cash offsetting this, leading to net cash of JP¥17.7b.

How Healthy Is Digital Holdings' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Digital Holdings had liabilities of JP¥10.3b due within 12 months and liabilities of JP¥4.83b due beyond that. On the other hand, it had cash of JP¥21.7b and JP¥13.5b worth of receivables due within a year. So it can boast JP¥20.1b more liquid assets than total liabilities.

This surplus liquidity suggests that Digital Holdings' balance sheet could take a hit just as well as Homer Simpson's head can take a punch. With this in mind one could posit that its balance sheet means the company is able to handle some adversity. Simply put, the fact that Digital Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.

Check out our latest analysis for Digital Holdings

On top of that, Digital Holdings grew its EBIT by 60% 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 Digital Holdings'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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Digital Holdings 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. Over the last two years, Digital Holdings actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

While it is always sensible to investigate a company's debt, in this case Digital Holdings has JP¥17.7b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 184% of that EBIT to free cash flow, bringing in JP¥6.7b. The bottom line is that Digital Holdings's use of debt is absolutely fine. 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. Be aware that Digital Holdings is showing 2 warning signs in our investment analysis , and 1 of those is potentially serious...

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.