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Warren Buffett famously said, ‘Volatility is far from synonymous with risk.’ So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Electro-Sensors, Inc. (NASDAQ:ELSE) does carry debt. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. When we examine debt levels, we first consider both cash and debt levels, together.
View our latest analysis for Electro-Sensors
How Much Debt Does Electro-Sensors Carry?
You can click the graphic below for the historical numbers, but it shows that as of March 2019 Electro-Sensors had US$28.0k of debt, an increase on none, over one year. But it also has US$8.69m in cash to offset that, meaning it has US$8.66m net cash.
How Strong Is Electro-Sensors’s Balance Sheet?
According to the last reported balance sheet, Electro-Sensors had liabilities of US$629.0k due within 12 months, and liabilities of US$23.0k due beyond 12 months. Offsetting this, it had US$8.69m in cash and US$1.09m in receivables that were due within 12 months. So it actually has US$9.12m more liquid assets than total liabilities.
This surplus strongly suggests that Electro-Sensors has a rock-solid balance sheet (and the debt is of no concern whatsoever). Having regard to this fact, we think its balance sheet is just as strong as misogynists are weak. Given that Electro-Sensors has more cash than debt, we’re pretty confident it can manage its debt safely.
The modesty of its debt load may become crucial for Electro-Sensors if management cannot prevent a repeat of the 78% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Electro-Sensors’s earnings that will influence how the balance sheet holds up in the future. So if you’re keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Electro-Sensors 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. Over the last two years, Electro-Sensors actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us excited like the crowd when the beat drops at a Daft Punk concert.
Summing up
While it is always sensible to investigate a company’s debt, in this case Electro-Sensors has US$8.7m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 173% of that EBIT to free cash flow, bringing in US$180k. So is Electro-Sensors’s debt a risk? It doesn’t seem so to us. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you’ve also come to that realization, you’re in luck, because today you can view this interactive graph of Electro-Sensors’s earnings per share history for free.
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.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.
