We Think Smith Douglas Homes (NYSE:SDHC) Can Stay On Top Of Its Debt

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 Smith Douglas Homes Corp. (NYSE:SDHC) does use debt in its business. But should shareholders be worried about its use of debt?

Trump has pledged to "unleash" American oil and gas and these 15 US stocks have developments that are poised to benefit.

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

How Much Debt Does Smith Douglas Homes Carry?

The image below, which you can click on for greater detail, shows that at June 2025 Smith Douglas Homes had debt of US$74.1m, up from US$8.86m in one year. On the flip side, it has US$16.8m in cash leading to net debt of about US$57.3m.

How Strong Is Smith Douglas Homes' Balance Sheet?

The latest balance sheet data shows that Smith Douglas Homes had liabilities of US$36.6m due within a year, and liabilities of US$118.8m falling due after that. On the other hand, it had cash of US$16.8m and US$100.0k worth of receivables due within a year. So its liabilities total US$138.5m more than the combination of its cash and short-term receivables.

Of course, Smith Douglas Homes has a market capitalization of US$1.03b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

View our latest analysis for Smith Douglas Homes

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). 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).

Smith Douglas Homes's net debt is only 0.52 times its EBITDA. And its EBIT covers its interest expense a whopping 40.8 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. On the other hand, Smith Douglas Homes saw its EBIT drop by 5.1% in the last twelve months. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Smith Douglas Homes's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. In the last three years, Smith Douglas Homes's free cash flow amounted to 35% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

When it comes to the balance sheet, the standout positive for Smith Douglas Homes was the fact that it seems able to cover its interest expense with its EBIT confidently. But the other factors we noted above weren't so encouraging. For example, its EBIT growth rate makes us a little nervous about its debt. When we consider all the elements mentioned above, it seems to us that Smith Douglas Homes is managing its debt quite well. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 2 warning signs with Smith Douglas Homes (at least 1 which shouldn't be ignored) , and understanding them should be part of your investment process.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.