Is Diodes (NASDAQ:DIOD) Using Too Much Debt?

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.' 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 Diodes Incorporated (NASDAQ:DIOD) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. 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 examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Diodes

What Is Diodes's Net Debt?

As you can see below, Diodes had US$62.1m of debt at December 2023, down from US$185.4m a year prior. However, it does have US$325.6m in cash offsetting this, leading to net cash of US$263.5m.

How Healthy Is Diodes' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Diodes had liabilities of US$393.5m due within 12 months and liabilities of US$164.5m due beyond that. Offsetting these obligations, it had cash of US$325.6m as well as receivables valued at US$371.9m due within 12 months. So it actually has US$139.6m more liquid assets than total liabilities.

This surplus suggests that Diodes has a conservative balance sheet, and could probably eliminate its debt without much difficulty. 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 38% in the last twelve months. 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 it is future earnings, more than anything, that will determine Diodes'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 company can only pay off debt with cold hard cash, not accounting profits. 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. During the last three years, Diodes produced sturdy free cash flow equating to 55% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While it is always sensible to investigate a company's debt, in this case Diodes has US$263.5m in net cash and a decent-looking balance sheet. So we don't have any problem with Diodes's use of debt. 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. We've identified 2 warning signs with Diodes (at least 1 which is a bit unpleasant) , and understanding them should be part of your investment process.

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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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.