Is Palo Alto Networks (NASDAQ:PANW) 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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Palo Alto Networks, Inc. (NASDAQ:PANW) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Palo Alto Networks

How Much Debt Does Palo Alto Networks Carry?

The image below, which you can click on for greater detail, shows that Palo Alto Networks had debt of US$963.9m at the end of July 2024, a reduction from US$1.99b over a year. However, it does have US$2.58b in cash offsetting this, leading to net cash of US$1.61b.

How Strong Is Palo Alto Networks' Balance Sheet?

We can see from the most recent balance sheet that Palo Alto Networks had liabilities of US$7.68b falling due within a year, and liabilities of US$7.14b due beyond that. On the other hand, it had cash of US$2.58b and US$3.34b worth of receivables due within a year. So its liabilities total US$8.90b more than the combination of its cash and short-term receivables.

Given Palo Alto Networks has a humongous market capitalization of US$123.2b, it's hard to believe these liabilities pose much 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, Palo Alto Networks also has more cash than debt, so we're pretty confident it can manage its debt safely.

Better yet, Palo Alto Networks grew its EBIT by 129% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Palo Alto Networks'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. Palo Alto Networks 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 two years, Palo Alto Networks actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

We could understand if investors are concerned about Palo Alto Networks's liabilities, but we can be reassured by the fact it has has net cash of US$1.61b. And it impressed us with free cash flow of US$3.1b, being 449% of its EBIT. So is Palo Alto Networks's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 3 warning signs with Palo Alto Networks (at least 1 which can't be ignored) , and understanding them should be part of your investment process.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.