Howard Marks said it well when he said that, rather than worrying about stock price volatility, “the possibility of permanent loss is the risk I worry about…and that every practical investor that I know is worried”. So it may be obvious that you need to take debt into account when thinking about the risk of a given stock, because too much debt can sink a business. Like many other companies SA patent (WSE:PAT) uses debt. But the more important question is: what risk does this debt create?
When is debt dangerous?
Debt helps a business until the business struggles to pay it back, either with new capital or with free cash flow. In the worst case, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still costly) situation is when a company has to dilute shareholders at a cheap share price just to keep debt under control. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business has is to look at its cash and debt together.
See our latest analysis for Patentus
What is Patentus’ debt?
As you can see below, Patentus had a debt of 16.4 million zł in March 2022, compared to 17.2 million zł the previous year. However, he also had 1.04 million zł of cash, and therefore his net debt is 15.4 million zł.
A look at the responsibilities of Patentus
We can see from the most recent balance sheet that Patentus had liabilities of zł 19.1 million due in one year, and liabilities of zł 23.2 million due beyond. On the other hand, he had cash of 1.04 million zł and 12.9 million zł of receivables due within the year. Thus, its debts exceed the sum of its cash and (short-term) receivables by 28.5 million zł.
This deficit is considerable compared to its market capitalization of 45.7 million zł, so it suggests that shareholders monitor the use of debt by Patentus. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet quickly. When analyzing debt levels, the balance sheet is the obvious starting point. But you can’t look at debt in total isolation; since Patentus will need income to repay this debt. So, when considering debt, it is definitely worth looking at the earnings trend. Click here for an interactive preview.
Over 12 months, Patentus saw its revenues remain fairly stable and did not post positive earnings before interest and taxes. While that’s not too bad, we’d rather see growth.
Importantly, Patentus posted a loss in earnings before interest and taxes (EBIT) over the past year. To be precise, the EBIT loss amounted to 4.4 million zł. When we look at this and recall the liabilities on its balance sheet, versus cash, it seems unwise to us that the company has debt. So we think its balance sheet is a little stretched, but not beyond repair. Another cause for caution is that it has lost zł 16 million of negative free cash flow over the past twelve months. So suffice it to say that we consider the stock to be very risky. There is no doubt that we learn the most about debt from the balance sheet. But at the end of the day, every business can contain risks that exist outside of the balance sheet. These risks can be difficult to spot. Every business has them, and we’ve spotted 3 warning signs for Patentus (2 of which don’t really suit us!) that you should know.
If you are interested in investing in companies that can generate profits without the burden of debt, then check out this free list of growing companies that have net cash on the balance sheet.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.
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