Is ServiceNow (NYSE:NOW) A Risky Investment?

Published
July 03, 2022
NYSE:NOW
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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.' 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 ServiceNow, Inc. (NYSE:NOW) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for ServiceNow

What Is ServiceNow's Debt?

As you can see below, ServiceNow had US$1.57b of debt, at March 2022, which is about the same as the year before. You can click the chart for greater detail. But it also has US$4.01b in cash to offset that, meaning it has US$2.44b net cash.

debt-equity-history-analysis
NYSE:NOW Debt to Equity History July 3rd 2022

A Look At ServiceNow's Liabilities

We can see from the most recent balance sheet that ServiceNow had liabilities of US$4.85b falling due within a year, and liabilities of US$2.14b due beyond that. Offsetting this, it had US$4.01b in cash and US$824.0m in receivables that were due within 12 months. So its liabilities total US$2.16b more than the combination of its cash and short-term receivables.

Of course, ServiceNow has a titanic market capitalization of US$97.1b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, ServiceNow also has more cash than debt, so we're pretty confident it can manage its debt safely.

While ServiceNow doesn't seem to have gained much on the EBIT line, at least earnings remain stable for now. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if ServiceNow 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 company can only pay off debt with cold hard cash, not accounting profits. ServiceNow 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. Happily for any shareholders, ServiceNow actually produced more free cash flow than EBIT over the last three years. 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 ServiceNow's liabilities, but we can be reassured by the fact it has has net cash of US$2.44b. And it impressed us with free cash flow of US$1.9b, being 749% of its EBIT. So is ServiceNow's debt a risk? It doesn't seem so to us. 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. To that end, you should be aware of the 1 warning sign we've spotted with ServiceNow .

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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