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 Amazon.com, Inc. (NASDAQ:AMZN) makes use of debt. But should shareholders be worried about its use of debt?
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. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.
How Much Debt Does Amazon.com Carry?
The image below, which you can click on for greater detail, shows that at December 2020 Amazon.com had debt of US$33.7b, up from US$24.7b in one year. However, its balance sheet shows it holds US$84.4b in cash, so it actually has US$50.7b net cash.
How Strong Is Amazon.com's Balance Sheet?
According to the last reported balance sheet, Amazon.com had liabilities of US$126.4b due within 12 months, and liabilities of US$101.4b due beyond 12 months. Offsetting this, it had US$84.4b in cash and US$24.3b in receivables that were due within 12 months. So it has liabilities totalling US$119.1b more than its cash and near-term receivables, combined.
Since publicly traded Amazon.com shares are worth a very impressive total of US$1.69t, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, Amazon.com also has more cash than debt, so we're pretty confident it can manage its debt safely.
In addition to that, we're happy to report that Amazon.com has boosted its EBIT by 59%, thus reducing the spectre of future debt repayments. 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 Amazon.com'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. Amazon.com 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. Over the last three years, Amazon.com 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.
We could understand if investors are concerned about Amazon.com's liabilities, but we can be reassured by the fact it has has net cash of US$50.7b. The cherry on top was that in converted 130% of that EBIT to free cash flow, bringing in US$26b. So is Amazon.com's debt a risk? It doesn't seem so to us. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Amazon.com's earnings per share history for free.
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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