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.' 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 Alphabet Inc. (NASDAQ:GOOG.L) makes use of debt. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
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. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. 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 Alphabet Carry?
As you can see below, Alphabet had US$12.8b of debt at September 2021, down from US$13.8b a year prior. However, its balance sheet shows it holds US$142.0b in cash, so it actually has US$129.2b net cash.
How Strong Is Alphabet's Balance Sheet?
We can see from the most recent balance sheet that Alphabet had liabilities of US$61.8b falling due within a year, and liabilities of US$41.1b due beyond that. Offsetting this, it had US$142.0b in cash and US$34.8b in receivables that were due within 12 months. So it can boast US$74.0b more liquid assets than total liabilities.
This surplus suggests that Alphabet has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Alphabet boasts net cash, so it's fair to say it does not have a heavy debt load!
Even more impressive was the fact that Alphabet grew its EBIT by 108% over twelve months. That boost will make it even easier to pay down debt going forward. 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 Alphabet'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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Alphabet has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Alphabet generated free cash flow amounting to a very robust 90% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.
While it is always sensible to investigate a company's debt, in this case Alphabet has US$129.2b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of US$66b, being 90% of its EBIT. So we don't think Alphabet's use of debt is risky. Over time, share prices tend to follow earnings per share, so if you're interested in Alphabet, you may well want to click here to check an interactive graph of its earnings per share history.
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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