Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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. We note that Alphabet Inc. (NASDAQ:GOOG.L) does have debt on its balance sheet. 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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
How Much Debt Does Alphabet Carry?
You can click the graphic below for the historical numbers, but it shows that Alphabet had US$12.8b of debt in September 2021, down from US$13.8b, one year before. But it also has US$142.0b in cash to offset that, meaning it has US$129.2b net cash.
How Strong Is Alphabet's Balance Sheet?
The latest balance sheet data shows that Alphabet had liabilities of US$61.8b due within a year, and liabilities of US$41.1b falling due after that. Offsetting this, it had US$142.0b in cash and US$34.8b in receivables that were due within 12 months. So it actually has US$74.0b more liquid assets than total liabilities.
This short term liquidity is a sign that Alphabet could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Alphabet boasts net cash, so it's fair to say it does not have a heavy debt load!
Even more impressive was the fact that Alphabet grew its EBIT by 108% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. 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 Alphabet 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. Alphabet 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. During the last three years, Alphabet generated free cash flow amounting to a very robust 90% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.
Summing up
While we empathize with investors who find debt concerning, you should keep in mind that Alphabet has net cash of US$129.2b, as well as more liquid assets than liabilities. The cherry on top was that in converted 90% of that EBIT to free cash flow, bringing in US$66b. So is Alphabet's debt a risk? It doesn't seem so to us. Over time, share prices tend to follow earnings per share, so if you're interested in Alphabet, you may well want to click here to check an interactive graph of its earnings per share history.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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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.
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