Is Diodes (NASDAQ:DIOD) A Risky Investment?

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 note that Diodes Incorporated (NASDAQ:DIOD) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Diodes

What Is Diodes's Net Debt?

As you can see below, at the end of September 2024, Diodes had US$57.9m of debt, up from US$53.2m a year ago. Click the image for more detail. However, its balance sheet shows it holds US$319.3m in cash, so it actually has US$261.5m net cash.

How Strong Is Diodes' Balance Sheet?

We can see from the most recent balance sheet that Diodes had liabilities of US$352.8m falling due within a year, and liabilities of US$153.3m due beyond that. Offsetting these obligations, it had cash of US$319.3m as well as receivables valued at US$358.9m due within 12 months. So it actually has US$172.2m more liquid assets than total liabilities.

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

In fact Diodes's saving grace is its low debt levels, because its EBIT has tanked 82% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. 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 Diodes'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Diodes 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. In the last three years, Diodes's free cash flow amounted to 41% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While it is always sensible to investigate a company's debt, in this case Diodes has US$261.5m in net cash and a decent-looking balance sheet. So we don't have any problem with Diodes's use of debt. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 1 warning sign for Diodes 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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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.