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Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 Pureprofile Ltd (ASX:PPL) makes use of debt. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
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 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Pureprofile's Debt?
As you can see below, Pureprofile had AU$3.00m of debt, at December 2021, which is about the same as the year before. You can click the chart for greater detail. However, its balance sheet shows it holds AU$4.67m in cash, so it actually has AU$1.67m net cash.
A Look At Pureprofile's Liabilities
We can see from the most recent balance sheet that Pureprofile had liabilities of AU$11.6m falling due within a year, and liabilities of AU$4.99m due beyond that. On the other hand, it had cash of AU$4.67m and AU$7.94m worth of receivables due within a year. So its liabilities total AU$3.94m more than the combination of its cash and short-term receivables.
Of course, Pureprofile has a market capitalization of AU$49.8m, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Pureprofile also has more cash than debt, so we're pretty confident it can manage its debt safely. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Pureprofile's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Over 12 months, Pureprofile reported revenue of AU$36m, which is a gain of 43%, although it did not report any earnings before interest and tax. With any luck the company will be able to grow its way to profitability.
So How Risky Is Pureprofile?
While Pureprofile lost money on an earnings before interest and tax (EBIT) level, it actually generated positive free cash flow AU$1.7m. So taking that on face value, and considering the net cash situation, we don't think that the stock is too risky in the near term. The good news for Pureprofile shareholders is that its revenue growth is strong, making it easier to raise capital if need be. But that doesn't change our opinion that the stock is risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 3 warning signs we've spotted with Pureprofile .
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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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.