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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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, CoStar Group, Inc. (NASDAQ:CSGP) does carry debt. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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 examine debt levels, we first consider both cash and debt levels, together.
What Is CoStar Group's Debt?
As you can see below, CoStar Group had US$987.6m of debt, at September 2021, which is about the same as the year before. You can click the chart for greater detail. But it also has US$3.76b in cash to offset that, meaning it has US$2.77b net cash.
How Healthy Is CoStar Group's Balance Sheet?
According to the last reported balance sheet, CoStar Group had liabilities of US$321.5m due within 12 months, and liabilities of US$1.21b due beyond 12 months. On the other hand, it had cash of US$3.76b and US$115.7m worth of receivables due within a year. So it actually has US$2.35b more liquid assets than total liabilities.
This short term liquidity is a sign that CoStar Group could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that CoStar Group has more cash than debt is arguably a good indication that it can manage its debt safely.
Fortunately, CoStar Group grew its EBIT by 3.6% in the last year, making that debt load look even more manageable. 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 CoStar Group 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.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While CoStar Group 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. Over the last three years, CoStar Group actually produced more free cash flow than EBIT. 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 CoStar Group has US$2.77b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of US$299m, being 107% of its EBIT. So we don't think CoStar Group's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that CoStar Group is showing 1 warning sign in our investment analysis , you should know about...
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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.
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