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.’ It’s only natural to consider a company’s balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Shopify Inc. (NYSE:SHOP) does have debt on its balance sheet. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
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. If things get really bad, the lenders can take control of the business. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.
See our latest analysis for Shopify
What Is Shopify’s Debt?
The chart below, which you can click on for greater detail, shows that Shopify had US$912.7m in debt in September 2022; about the same as the year before. However, its balance sheet shows it holds US$4.94b in cash, so it actually has US$4.03b net cash.
A Look At Shopify’s Liabilities
Zooming in on the latest balance sheet data, we can see that Shopify had liabilities of US$905.2m due within 12 months and liabilities of US$1.61b due beyond that. Offsetting these obligations, it had cash of US$4.94b as well as receivables valued at US$460.8m due within 12 months. So it actually has US$2.89b more liquid assets than total liabilities.
This short term liquidity is a sign that Shopify could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Shopify has more cash than debt is arguably a good indication that it can manage its debt safely. 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 Shopify 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.
In the last year Shopify wasn’t profitable at an EBIT level, but managed to grow its revenue by 25%, to US$5.2b. Shareholders probably have their fingers crossed that it can grow its way to profits.
So How Risky Is Shopify?
Statistically speaking companies that lose money are riskier than those that make money. And in the last year Shopify had an earnings before interest and tax (EBIT) loss, truth be told. Indeed, in that time it burnt through US$200m of cash and made a loss of US$3.2b. While this does make the company a bit risky, it’s important to remember it has net cash of US$4.03b. That means it could keep spending at its current rate for more than two years. With very solid revenue growth in the last year, Shopify may be on a path to profitability. By investing before those profits, shareholders take on more risk in the hope of bigger rewards. When I consider a company to be a bit risky, I think it is responsible to check out whether insiders have been reporting any share sales. Luckily, you can click here ito see our graphic depicting Shopify insider transactions.
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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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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