Legendary fund manager Li Lu (whom Charlie Munger once backed) once said, “The greatest risk in investing is not price volatility, but whether you will suffer a permanent loss of capital. When we think of a company’s risk, we always like to look at its use of debt, because over-indebtedness can lead to ruin. We can see that Digital Domain Holdings Limited (HKG:547) uses debt in his business. But the real question is whether this debt makes the business risky.
What risk does debt carry?
Generally speaking, debt only becomes a real problem when a company cannot easily repay it, either by raising capital or with its own cash flow. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. 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 flow and debt together.
See our latest analysis for Digital Domain Holdings
How much debt does Digital Domain Holdings have?
As you can see below, Digital Domain Holdings had HK$288.4 million in debt as of December 2021, roughly the same as the previous year. You can click on the graph for more details. On the other hand, he has HK$253.1 million in cash, resulting in a net debt of around HK$35.3 million.
How healthy is Digital Domain Holdings’ balance sheet?
The latest balance sheet data shows that Digital Domain Holdings had liabilities of HK$341.4 million due within one year, and liabilities of HK$347.9 million falling due by the after. In return, he had HK$253.1 million in cash and HK$138.9 million in debt due within 12 months. Thus, its liabilities total HK$297.3 million more than the combination of its cash and short-term receivables.
Given that publicly traded shares of Digital Domain Holdings are worth a total of HK$2.55 billion, it seems unlikely that this level of liability is a major threat. That said, it is clear that we must continue to monitor its record, lest it deteriorate. But either way, Digital Domain Holdings has virtually no net debt, so it’s fair to say that it doesn’t have a lot of debt! There is no doubt that we learn the most about debt from the balance sheet. But you can’t look at debt in total isolation; since Digital Domain Holdings will need revenue to repay this debt. So, when considering debt, it is definitely worth looking at the earnings trend. Click here for an interactive preview.
Year-over-year, Digital Domain Holdings reported revenue of HK$864 million, a 44% gain, although it reported no earnings before interest and taxes. With a little luck, the company will be able to progress towards profitability.
Despite the growth in revenue, Digital Domain Holdings still posted a loss in earnings before interest and taxes (EBIT) over the past year. Indeed, it lost HK$239 million in EBIT. Considering that alongside the liabilities mentioned above, this doesn’t give us much confidence that the company should use so much debt. So we think its balance sheet is a little stretched, but not beyond repair. For example, we wouldn’t want to see a repeat of last year’s HK$722 million loss. We therefore believe that this title is quite 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. We have identified 3 warning signs with Digital Domain Holdings (at least 1 which doesn’t sit well with us), and understanding them should be part of your investment process.
If, after all that, you’re more interested in a fast-growing company with a strong balance sheet, check out our list of cash-neutral growth stocks right away.
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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.