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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Alphabet Inc. (NASDAQ:GOOGL) does use debt in its business. But the real question is whether this debt is making the company risky.
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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. When we think about a company's use of debt, we first look at cash and debt together.
What Is Alphabet's Debt?
As you can see below, Alphabet had US$11.9b of debt at June 2023, down from US$12.9b a year prior. But it also has US$118.3b in cash to offset that, meaning it has US$106.5b net cash.
How Strong Is Alphabet's Balance Sheet?
According to the last reported balance sheet, Alphabet had liabilities of US$77.7b due within 12 months, and liabilities of US$38.2b due beyond 12 months. On the other hand, it had cash of US$118.3b and US$38.8b worth of receivables due within a year. So it can boast US$41.2b 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. Simply put, the fact that Alphabet has more cash than debt is arguably a good indication that it can manage its debt safely.
But the other side of the story is that Alphabet saw its EBIT decline by 7.2% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Alphabet can strengthen its balance sheet over time. 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. Alphabet 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. During the last three years, Alphabet generated free cash flow amounting to a very robust 88% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.
While we empathize with investors who find debt concerning, you should keep in mind that Alphabet has net cash of US$106.5b, as well as more liquid assets than liabilities. The cherry on top was that in converted 88% of that EBIT to free cash flow, bringing in US$71b. 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, 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.
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