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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. Importantly, Software Aktiengesellschaft (ETR:SOW) does carry debt. But the real question is whether this debt is making the company risky.
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 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. When we think about a company's use of debt, we first look at cash and debt together.
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What Is Software's Debt?
The image below, which you can click on for greater detail, shows that at June 2019 Software had debt of €333.5m, up from €315.2m in one year. But on the other hand it also has €517.5m in cash, leading to a €184.1m net cash position.
How Strong Is Software's Balance Sheet?
The latest balance sheet data shows that Software had liabilities of €515.6m due within a year, and liabilities of €272.1m falling due after that. On the other hand, it had cash of €517.5m and €201.9m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by €68.3m.
Of course, Software has a market capitalization of €1.87b, 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, Software also has more cash than debt, so we're pretty confident it can manage its debt safely.
On the other hand, Software saw its EBIT drop by 2.2% in the last twelve months. That sort of decline, if sustained, will obviously make debt harder to handle. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Software can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.