Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 World Wrestling Entertainment, Inc. (NYSE:WWE) does use debt in its business. But the real question is whether this debt is making the company risky.
When Is Debt Dangerous?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is World Wrestling Entertainment's Debt?
The image below, which you can click on for greater detail, shows that at December 2020 World Wrestling Entertainment had debt of US$316.8m, up from US$214.4m in one year. However, its balance sheet shows it holds US$593.4m in cash, so it actually has US$276.6m net cash.
A Look At World Wrestling Entertainment's Liabilities
According to the last reported balance sheet, World Wrestling Entertainment had liabilities of US$496.3m due within 12 months, and liabilities of US$412.3m due beyond 12 months. Offsetting this, it had US$593.4m in cash and US$52.0m in receivables that were due within 12 months. So it has liabilities totalling US$263.1m more than its cash and near-term receivables, combined.
Since publicly traded World Wrestling Entertainment shares are worth a total of US$4.37b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, World Wrestling Entertainment boasts net cash, so it's fair to say it does not have a heavy debt load!
On top of that, World Wrestling Entertainment grew its EBIT by 84% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine World Wrestling Entertainment'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.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While World Wrestling Entertainment 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. Over the last three years, World Wrestling Entertainment actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.
While it is always sensible to look at a company's total liabilities, it is very reassuring that World Wrestling Entertainment has US$276.6m in net cash. And it impressed us with free cash flow of US$292m, being 108% of its EBIT. So we don't think World Wrestling Entertainment's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 1 warning sign for World Wrestling Entertainment that you should be aware of.
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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