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 NVIDIA Corporation (NASDAQ:NVDA) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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 step when considering a company's debt levels is to consider its cash and debt together.
What Is NVIDIA's Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of April 2020 NVIDIA had US$6.96b of debt, an increase on US$1.99b, over one year. But it also has US$16.4b in cash to offset that, meaning it has US$9.40b net cash.
A Look At NVIDIA's Liabilities
According to the last reported balance sheet, NVIDIA had liabilities of US$1.90b due within 12 months, and liabilities of US$8.25b due beyond 12 months. Offsetting this, it had US$16.4b in cash and US$1.91b in receivables that were due within 12 months. So it actually has US$8.11b more liquid assets than total liabilities.
This surplus suggests that NVIDIA has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that NVIDIA has more cash than debt is arguably a good indication that it can manage its debt safely.
Also positive, NVIDIA grew its EBIT by 20% in the last year, and that should make it easier to pay down debt, going forward. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if NVIDIA 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. While NVIDIA has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Happily for any shareholders, NVIDIA actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.
While it is always sensible to investigate a company's debt, in this case NVIDIA has US$9.40b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of US$4.4b, being 105% of its EBIT. So is NVIDIA's debt a risk? It doesn't seem so to us. 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. Take risks, for example - NVIDIA has 3 warning signs we think you should be aware of.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
This article by Simply Wall St is general in nature. 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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