Is GameStop (NYSE:GME) A Risky Investment?

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. We can see that GameStop Corp. (NYSE:GME) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for GameStop

What Is GameStop's Net Debt?

The image below, which you can click on for greater detail, shows that GameStop had debt of US$38.7m at the end of October 2022, a reduction from US$46.2m over a year. However, it does have US$1.04b in cash offsetting this, leading to net cash of US$1.00b.

How Healthy Is GameStop's Balance Sheet?

According to the last reported balance sheet, GameStop had liabilities of US$1.59b due within 12 months, and liabilities of US$488.8m due beyond 12 months. On the other hand, it had cash of US$1.04b and US$293.9m worth of receivables due within a year. So its liabilities total US$741.5m more than the combination of its cash and short-term receivables.

Since publicly traded GameStop shares are worth a total of US$5.58b, 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. While it does have liabilities worth noting, GameStop also has more cash than debt, so we're pretty confident it can manage its debt safely. 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 GameStop'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.

Over 12 months, GameStop saw its revenue hold pretty steady, and it did not report positive earnings before interest and tax. While that's not too bad, we'd prefer see growth.

So How Risky Is GameStop?

By their very nature companies that are losing money are more risky than those with a long history of profitability. And in the last year GameStop had an earnings before interest and tax (EBIT) loss, truth be told. And over the same period it saw negative free cash outflow of US$643m and booked a US$509m accounting loss. Given it only has net cash of US$1.00b, the company may need to raise more capital if it doesn't reach break-even soon. Summing up, we're a little skeptical of this one, as it seems fairly risky in the absence of free cashflow. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - GameStop has 1 warning sign we think you should be aware of.

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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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.