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Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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, Overstock.com, Inc. (NASDAQ:OSTK) does carry debt. But is this debt a concern to shareholders?
When Is Debt Dangerous?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Overstock.com's Net Debt?
As you can see below, Overstock.com had US$40.5m of debt at March 2022, down from US$43.7m a year prior. However, it does have US$493.3m in cash offsetting this, leading to net cash of US$452.8m.
A Look At Overstock.com's Liabilities
The latest balance sheet data shows that Overstock.com had liabilities of US$284.6m due within a year, and liabilities of US$47.3m falling due after that. Offsetting this, it had US$493.3m in cash and US$23.7m in receivables that were due within 12 months. So it actually has US$185.2m more liquid assets than total liabilities.
This short term liquidity is a sign that Overstock.com could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Overstock.com has more cash than debt is arguably a good indication that it can manage its debt safely.
In fact Overstock.com's saving grace is its low debt levels, because its EBIT has tanked 24% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Overstock.com's ability to maintain a healthy balance sheet going forward. 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 company can only pay off debt with cold hard cash, not accounting profits. While Overstock.com 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 two years, Overstock.com 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 Overstock.com has US$452.8m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of US$38m, being 131% of its EBIT. So we are not troubled with Overstock.com's debt use. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 1 warning sign for Overstock.com that you should be aware of.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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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.