Is Genius Electronic Optical (TPE:3406) 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 Genius Electronic Optical Co., Ltd. (TPE:3406) makes use of debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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.

View our latest analysis for Genius Electronic Optical

What Is Genius Electronic Optical's Debt?

The chart below, which you can click on for greater detail, shows that Genius Electronic Optical had NT$3.81b in debt in September 2020; about the same as the year before. However, it also had NT$1.71b in cash, and so its net debt is NT$2.10b.

How Strong Is Genius Electronic Optical's Balance Sheet?

According to the last reported balance sheet, Genius Electronic Optical had liabilities of NT$5.87b due within 12 months, and liabilities of NT$3.79b due beyond 12 months. On the other hand, it had cash of NT$1.71b and NT$4.58b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$3.37b.

Since publicly traded Genius Electronic Optical shares are worth a total of NT$56.8b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Genius Electronic Optical has a low net debt to EBITDA ratio of only 0.35. And its EBIT covers its interest expense a whopping 68.5 times over. So we're pretty relaxed about its super-conservative use of debt. On top of that, Genius Electronic Optical grew its EBIT by 74% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Genius Electronic Optical can strengthen its balance sheet over time. 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. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. In the last three years, Genius Electronic Optical's free cash flow amounted to 29% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

Happily, Genius Electronic Optical's impressive interest cover implies it has the upper hand on its debt. But, on a more sombre note, we are a little concerned by its conversion of EBIT to free cash flow. Looking at the bigger picture, we think Genius Electronic Optical's use of debt seems quite reasonable and we're not concerned about it. After all, sensible leverage can boost returns on equity. Over time, share prices tend to follow earnings per share, so if you're interested in Genius Electronic Optical, you may well want to click here to check an interactive graph of its earnings per share history.

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. 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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