CoStar Group (NASDAQ:CSGP) Could Easily Take On More Debt

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. As with many other companies CoStar Group, Inc. (NASDAQ:CSGP) makes use of debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for CoStar Group

How Much Debt Does CoStar Group Carry?

The chart below, which you can click on for greater detail, shows that CoStar Group had US$989.2m in debt in December 2022; about the same as the year before. But it also has US$4.97b in cash to offset that, meaning it has US$3.98b net cash.

How Healthy Is CoStar Group's Balance Sheet?

The latest balance sheet data shows that CoStar Group had liabilities of US$372.6m due within a year, and liabilities of US$1.16b falling due after that. On the other hand, it had cash of US$4.97b and US$153.9m worth of receivables due within a year. So it actually has US$3.59b more liquid assets than total liabilities.

This short term liquidity is a sign that CoStar Group could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that CoStar Group has more cash than debt is arguably a good indication that it can manage its debt safely.

Fortunately, CoStar Group grew its EBIT by 4.3% in the last year, making that debt load look even more manageable. 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 CoStar Group'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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. CoStar Group 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 three years, CoStar Group recorded free cash flow worth a fulsome 94% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case CoStar Group has US$3.98b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 94% of that EBIT to free cash flow, bringing in US$385m. So we don't think CoStar Group's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Be aware that CoStar Group is showing 1 warning sign in our investment analysis , 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.