Is Super Micro Computer (NASDAQ:SMCI) A Risky Investment?

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.' 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. As with many other companies Super Micro Computer, Inc. (NASDAQ:SMCI) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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, 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.

Check out our latest analysis for Super Micro Computer

How Much Debt Does Super Micro Computer Carry?

As you can see below, at the end of March 2024, Super Micro Computer had US$1.86b of debt, up from US$187.2m a year ago. Click the image for more detail. However, its balance sheet shows it holds US$2.12b in cash, so it actually has US$252.0m net cash.

A Look At Super Micro Computer's Liabilities

We can see from the most recent balance sheet that Super Micro Computer had liabilities of US$1.72b falling due within a year, and liabilities of US$2.05b due beyond that. On the other hand, it had cash of US$2.12b and US$1.68b worth of receivables due within a year. So these liquid assets roughly match the total liabilities.

This state of affairs indicates that Super Micro Computer's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the US$52.0b company is struggling for cash, we still think it's worth monitoring its balance sheet. Simply put, the fact that Super Micro Computer has more cash than debt is arguably a good indication that it can manage its debt safely.

On top of that, Super Micro Computer grew its EBIT by 64% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Super Micro Computer can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Super Micro Computer 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 three years, Super Micro Computer saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

While it is always sensible to investigate a company's debt, in this case Super Micro Computer has US$252.0m in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 64% over the last year. So we are not troubled with Super Micro Computer's debt use. 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. We've identified 4 warning signs with Super Micro Computer (at least 2 which are potentially serious) , and understanding them should be part of your investment process.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.