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.' 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. As with many other companies Lvji Technology Holdings Inc. (HKG:1745) makes use of debt. But should shareholders be worried about its use of debt?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.
View our latest analysis for Lvji Technology Holdings
The image below, which you can click on for greater detail, shows that at June 2024 Lvji Technology Holdings had debt of CN¥30.0m, up from none in one year. However, it does have CN¥160.0m in cash offsetting this, leading to net cash of CN¥130.0m.
The latest balance sheet data shows that Lvji Technology Holdings had liabilities of CN¥192.4m due within a year, and liabilities of CN¥9.77m falling due after that. Offsetting these obligations, it had cash of CN¥160.0m as well as receivables valued at CN¥66.9m due within 12 months. So it can boast CN¥24.7m more liquid assets than total liabilities.
This short term liquidity is a sign that Lvji Technology Holdings could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Lvji Technology Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.
Even more impressive was the fact that Lvji Technology Holdings grew its EBIT by 212% over twelve months. That boost will make it even easier to pay down debt going forward. There's no doubt that we learn most about debt from the balance sheet. But it is Lvji Technology Holdings's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Lvji Technology Holdings 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. During the last three years, Lvji Technology Holdings burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.
While we empathize with investors who find debt concerning, you should keep in mind that Lvji Technology Holdings has net cash of CN¥130.0m, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 212% over the last year. So we don't have any problem with Lvji Technology Holdings's use of debt. 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 Lvji Technology Holdings (at least 1 which can't be ignored) , and understanding them should be part of your investment process.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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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.