Is Teradyne (NASDAQ:TER) A Risky Investment?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Teradyne, Inc. (NASDAQ:TER) makes use of debt. But the more important question is: how much risk is that debt creating?

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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

Check out our latest analysis for Teradyne

How Much Debt Does Teradyne Carry?

The image below, which you can click on for greater detail, shows that Teradyne had debt of US$95.9m at the end of April 2022, a reduction from US$367.9m over a year. But on the other hand it also has US$1.08b in cash, leading to a US$980.7m net cash position.

A Look At Teradyne's Liabilities

The latest balance sheet data shows that Teradyne had liabilities of US$712.2m due within a year, and liabilities of US$422.4m falling due after that. Offsetting this, it had US$1.08b in cash and US$546.9m in receivables that were due within 12 months. So it actually has US$488.9m more liquid assets than total liabilities.

This surplus suggests that Teradyne has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Teradyne has more cash than debt is arguably a good indication that it can manage its debt safely.

Another good sign is that Teradyne has been able to increase its EBIT by 26% in twelve months, making it easier to pay down debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Teradyne'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Teradyne 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, Teradyne produced sturdy free cash flow equating to 76% 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 Teradyne has US$980.7m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 76% of that EBIT to free cash flow, bringing in US$930m. So we don't think Teradyne's use of debt is risky. Over time, share prices tend to follow earnings per share, so if you're interested in Teradyne, you may well want to click here to check an interactive graph of its earnings per share history.

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.