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.' 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 Palo Alto Networks, Inc. (NASDAQ:PANW) does have debt on its balance sheet. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Palo Alto Networks

What Is Palo Alto Networks's Debt?

As you can see below, Palo Alto Networks had US$645.8m of debt at October 2024, down from US$1.95b a year prior. But it also has US$3.39b in cash to offset that, meaning it has US$2.75b net cash.

How Healthy Is Palo Alto Networks' Balance Sheet?

According to the last reported balance sheet, Palo Alto Networks had liabilities of US$7.40b due within 12 months, and liabilities of US$7.06b due beyond 12 months. Offsetting this, it had US$3.39b in cash and US$1.94b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$9.13b.

Since publicly traded Palo Alto Networks shares are worth a very impressive total of US$123.0b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. 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.

On top of that, Palo Alto Networks grew its EBIT by 56% over the last twelve months, and that growth will make it easier to handle its debt. 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 Palo Alto Networks's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Palo Alto Networks has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Happily for any shareholders, Palo Alto Networks actually produced more free cash flow than EBIT over the last two years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

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$2.75b. The cherry on top was that in converted 399% of that EBIT to free cash flow, bringing in US$3.1b. So is Palo Alto Networks's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Be aware that Palo Alto Networks is showing 2 warning signs in our investment analysis , and 1 of those is potentially serious...

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.