Is Adobe (NASDAQ:ADBE) 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.' 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 Adobe Inc. (NASDAQ:ADBE) makes use of debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.

Check out our latest analysis for Adobe

What Is Adobe's Debt?

You can click the graphic below for the historical numbers, but it shows that Adobe had US$3.63b of debt in December 2023, down from US$4.13b, one year before. But it also has US$7.84b in cash to offset that, meaning it has US$4.21b net cash.

How Healthy Is Adobe's Balance Sheet?

According to the last reported balance sheet, Adobe had liabilities of US$8.25b due within 12 months, and liabilities of US$5.01b due beyond 12 months. On the other hand, it had cash of US$7.84b and US$2.22b worth of receivables due within a year. So it has liabilities totalling US$3.20b more than its cash and near-term receivables, combined.

This state of affairs indicates that Adobe's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the US$272.6b company is struggling for cash, we still think it's worth monitoring its balance sheet. Despite its noteworthy liabilities, Adobe boasts net cash, so it's fair to say it does not have a heavy debt load!

The good news is that Adobe has increased its EBIT by 9.1% over twelve months, which should ease any concerns about debt repayment. 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 Adobe'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. Adobe 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, Adobe actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

We could understand if investors are concerned about Adobe's liabilities, but we can be reassured by the fact it has has net cash of US$4.21b. And it impressed us with free cash flow of US$7.6b, being 118% of its EBIT. So we don't think Adobe's use of debt is risky. Another factor that would give us confidence in Adobe would be if insiders have been buying shares: if you're conscious of that signal too, you can find out instantly by clicking this link.

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.