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.' 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. We note that RF Industries, Ltd. (NASDAQ:RFIL) does have debt on its balance sheet. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
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. 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.
How Much Debt Does RF Industries Carry?
As you can see below, at the end of October 2020, RF Industries had US$2.79m of debt, up from none a year ago. Click the image for more detail. But on the other hand it also has US$15.8m in cash, leading to a US$13.0m net cash position.
How Strong Is RF Industries' Balance Sheet?
The latest balance sheet data shows that RF Industries had liabilities of US$6.66m due within a year, and liabilities of US$2.09m falling due after that. Offsetting these obligations, it had cash of US$15.8m as well as receivables valued at US$5.67m due within 12 months. So it actually has US$12.7m more liquid assets than total liabilities.
It's good to see that RF Industries has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Simply put, the fact that RF Industries has more cash than debt is arguably a good indication that it can manage its debt safely. 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 RF Industries 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.
In the last year RF Industries had a loss before interest and tax, and actually shrunk its revenue by 22%, to US$43m. To be frank that doesn't bode well.
So How Risky Is RF Industries?
Although RF Industries had an earnings before interest and tax (EBIT) loss over the last twelve months, it generated positive free cash flow of US$4.3m. So although it is loss-making, it doesn't seem to have too much near-term balance sheet risk, keeping in mind the net cash. We'll feel more comfortable with the stock once EBIT is positive, given the lacklustre revenue growth. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Be aware that RF Industries is showing 3 warning signs in our investment analysis , you should know about...
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. 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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