Is CoStar Group (NASDAQ:CSGP) A Risky Investment?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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, CoStar Group, Inc. (NASDAQ:CSGP) does carry debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. 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.

View our latest analysis for CoStar Group

How Much Debt Does CoStar Group Carry?

As you can see below, CoStar Group had US$989.9m of debt, at June 2023, which is about the same as the year before. You can click the chart for greater detail. But it also has US$5.21b in cash to offset that, meaning it has US$4.22b net cash.

How Strong Is CoStar Group's Balance Sheet?

We can see from the most recent balance sheet that CoStar Group had liabilities of US$442.8m falling due within a year, and liabilities of US$1.15b due beyond that. On the other hand, it had cash of US$5.21b and US$186.0m worth of receivables due within a year. So it can boast US$3.80b more liquid assets than total liabilities.

This short term liquidity is a sign that CoStar Group could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, CoStar Group boasts net cash, so it's fair to say it does not have a heavy debt load!

It is just as well that CoStar Group's load is not too heavy, because its EBIT was down 22% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if CoStar Group can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While CoStar Group 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, CoStar Group generated free cash flow amounting to a very robust 95% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that CoStar Group has net cash of US$4.22b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of US$473m, being 95% of its EBIT. So we don't have any problem with CoStar Group's use of debt. 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. We've identified 1 warning sign with CoStar Group , and understanding them should be part of your investment process.

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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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.