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. We note that Mitek Systems, Inc. (NASDAQ:MITK) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
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. If things get really bad, the lenders can take control of the business. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
How Much Debt Does Mitek Systems Carry?
The image below, which you can click on for greater detail, shows that at June 2021 Mitek Systems had debt of US$120.5m, up from US$700.0k in one year. But on the other hand it also has US$178.9m in cash, leading to a US$58.3m net cash position.
How Healthy Is Mitek Systems' Balance Sheet?
We can see from the most recent balance sheet that Mitek Systems had liabilities of US$37.6m falling due within a year, and liabilities of US$196.3m due beyond that. Offsetting this, it had US$178.9m in cash and US$22.2m in receivables that were due within 12 months. So it has liabilities totalling US$32.8m more than its cash and near-term receivables, combined.
Since publicly traded Mitek Systems shares are worth a total of US$858.0m, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, Mitek Systems also has more cash than debt, so we're pretty confident it can manage its debt safely.
Even more impressive was the fact that Mitek Systems grew its EBIT by 104% over twelve months. That boost will make it even easier to pay down debt going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Mitek Systems can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Mitek Systems 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, Mitek Systems 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.
We could understand if investors are concerned about Mitek Systems's liabilities, but we can be reassured by the fact it has has net cash of US$58.3m. The cherry on top was that in converted 149% of that EBIT to free cash flow, bringing in US$31m. So we don't think Mitek Systems's use of debt is risky. 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 3 warning signs with Mitek Systems , and understanding them should be part of your investment process.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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.
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