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. Importantly, Alphabet Inc. (NASDAQ:GOOG.L) does carry debt. But the real question is whether this debt is making the company risky.
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. 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?
You can click the graphic below for the historical numbers, but it shows that as of September 2020 Alphabet had US$13.8b of debt, an increase on US$3.96b, over one year. However, its balance sheet shows it holds US$132.6b in cash, so it actually has US$118.8b net cash.
How Healthy Is Alphabet's Balance Sheet?
According to the last reported balance sheet, Alphabet had liabilities of US$48.2b due within 12 months, and liabilities of US$38.1b due beyond 12 months. Offsetting this, it had US$132.6b in cash and US$25.5b in receivables that were due within 12 months. So it can boast US$71.8b 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!
Alphabet's EBIT was pretty flat over the last year, but that shouldn't be an issue given the it doesn't have a lot of debt. 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 want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
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 83% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.
While we empathize with investors who find debt concerning, you should keep in mind that Alphabet has net cash of US$118.8b, as well as more liquid assets than liabilities. The cherry on top was that in converted 83% of that EBIT to free cash flow, bringing in US$34b. 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.
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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