These 4 Measures Indicate That Comstock Holding Companies (NASDAQ:CHCI) Is Using Debt Safely

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Comstock Holding Companies, Inc. (NASDAQ:CHCI) does use debt in its business. But the more important question is: how much risk is that debt creating?

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. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest 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 Comstock Holding Companies

What Is Comstock Holding Companies's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Comstock Holding Companies had US$5.44m of debt in September 2020, down from US$6.33m, one year before. However, it does have US$4.50m in cash offsetting this, leading to net debt of about US$936.0k.

A Look At Comstock Holding Companies's Liabilities

We can see from the most recent balance sheet that Comstock Holding Companies had liabilities of US$2.34m falling due within a year, and liabilities of US$5.50m due beyond that. Offsetting this, it had US$4.50m in cash and US$4.65m in receivables that were due within 12 months. So it actually has US$1.32m more liquid assets than total liabilities.

This short term liquidity is a sign that Comstock Holding Companies could probably pay off its debt with ease, as its balance sheet is far from stretched.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

With net debt sitting at just 0.24 times EBITDA, Comstock Holding Companies is arguably pretty conservatively geared. And this view is supported by the solid interest coverage, with EBIT coming in at 7.4 times the interest expense over the last year. Even more impressive was the fact that Comstock Holding Companies grew its EBIT by 224% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Comstock Holding Companies'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 company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last two years, Comstock Holding Companies actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

The good news is that Comstock Holding Companies's demonstrated ability to convert EBIT to free cash flow delights us like a fluffy puppy does a toddler. And that's just the beginning of the good news since its EBIT growth rate is also very heartening. We think Comstock Holding Companies is no more beholden to its lenders, than the birds are to birdwatchers. To our minds it has a healthy happy balance sheet. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 3 warning signs for Comstock Holding Companies you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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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