Legendary fund manager Li Lu (whom Charlie Munger once backed) once said, “The greatest risk in investing is not price volatility, but whether you will suffer a permanent loss of capital. So it may be obvious that you need to take debt into account when thinking about the risk of a given stock, because too much debt can sink a business. We note that Alphabet Inc. (NASDAQ:GOOGL) has debt on its balance sheet. But does this debt worry shareholders?
Why is debt risky?
Debt helps a business until the business struggles to pay it back, either with new capital or with free cash flow. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are mercilessly liquidated by their bankers. However, a more frequent (but still costly) event is when a company has to issue shares at bargain prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, many companies use debt to finance their growth, without any negative consequences. When we think about a company’s use of debt, we first look at cash and debt together.
See our latest analysis for Alphabet
What is Alphabet’s debt?
The image below, which you can click for more details, shows Alphabet had $12.8 billion in debt at the end of March 2022, down from $13.8 billion year-over-year. But it also has $134.0 billion in cash to offset that, which means it has $121.1 billion in net cash.
A look at Alphabet’s responsibilities
According to the last published balance sheet, Alphabet had liabilities of $61.9 billion maturing within 12 months and liabilities of $41.1 billion maturing beyond 12 months. On the other hand, it had $134.0 billion in cash and $35.6 billion in receivables at less than one year. So he actually has 66.5 billion US dollars After liquid assets than total liabilities.
This surplus suggests that Alphabet has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Alphabet has more cash than debt is arguably a good indication that it can safely manage its debt.
On top of that, we are happy to report that Alphabet has increased its EBIT by 66%, reducing the specter of future debt repayments. When analyzing debt levels, the balance sheet is the obvious starting point. But ultimately, the company’s future profitability will decide whether Alphabet can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
Finally, a company can only repay its debts with cold hard cash, not with book profits. Alphabet may have net cash on the balance sheet, but it’s always interesting to see how well the company converts its earnings before interest and tax (EBIT) into free cash flow, as this will influence both its need and its ability to manage debt. Over the past three years, Alphabet has recorded free cash flow of 88% of its EBIT, which is higher than what we would normally expect. This puts him in a very strong position to pay off the debt.
While it’s always a good idea to investigate a company’s debt, in this case Alphabet has $121.1 billion in net cash and a decent balance sheet. The icing on the cake was converting 88% of that EBIT into free cash flow, bringing in US$69 billion. We therefore do not believe that Alphabet’s use of debt is risky. Above most other metrics, we think it’s important to track how quickly earnings per share are growing, if at all. If you’ve also achieved this achievement, you’re in luck, because today you can view this interactive chart of Alphabet’s earnings per share history for free.
Of course, if you’re the type of investor who prefers to buy stocks without the burden of debt, then feel free to check out our exclusive list of cash-efficient growth stocks today.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.