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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Rich Goldman Holdings Limited (HKG:70) does use debt in its business. 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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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. When we think about a company's use of debt, we first look at cash and debt together.
View our latest analysis for Rich Goldman Holdings
How Much Debt Does Rich Goldman Holdings Carry?
As you can see below, at the end of June 2024, Rich Goldman Holdings had HK$211.6m of debt, up from HK$108.9m a year ago. Click the image for more detail. On the flip side, it has HK$77.2m in cash leading to net debt of about HK$134.4m.
A Look At Rich Goldman Holdings' Liabilities
We can see from the most recent balance sheet that Rich Goldman Holdings had liabilities of HK$193.6m falling due within a year, and liabilities of HK$146.8m due beyond that. Offsetting these obligations, it had cash of HK$77.2m as well as receivables valued at HK$137.6m due within 12 months. So it has liabilities totalling HK$125.5m more than its cash and near-term receivables, combined.
When you consider that this deficiency exceeds the company's HK$116.3m market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Rich Goldman 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.
In the last year Rich Goldman Holdings wasn't profitable at an EBIT level, but managed to grow its revenue by 29%, to HK$127m. With any luck the company will be able to grow its way to profitability.
Caveat Emptor
Despite the top line growth, Rich Goldman Holdings still had an earnings before interest and tax (EBIT) loss over the last year. To be specific the EBIT loss came in at HK$10m. Considering that alongside the liabilities mentioned above make us nervous about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. For example, we would not want to see a repeat of last year's loss of HK$50m. And until that time we think this is a risky stock. 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 3 warning signs with Rich Goldman Holdings (at least 1 which can't be ignored) , and understanding them should be part of your investment process.
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.