The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. We can see that CoStar Group, Inc. (NASDAQ:CSGP) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

How Much Debt Does CoStar Group Carry?

As you can see below, CoStar Group had US$990.8m of debt, at March 2024, which is about the same as the year before. You can click the chart for greater detail. But it also has US$4.95b in cash to offset that, meaning it has US$3.96b net cash.

How Strong Is CoStar Group's Balance Sheet?

According to the last reported balance sheet, CoStar Group had liabilities of US$573.8m due within 12 months, and liabilities of US$1.12b due beyond 12 months. Offsetting this, it had US$4.95b in cash and US$203.2m in receivables that were due within 12 months. So it actually has US$3.46b more liquid assets than total liabilities.

This surplus suggests that CoStar Group has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, CoStar Group boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact CoStar Group's saving grace is its low debt levels, because its EBIT has tanked 58% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine CoStar Group'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 business needs free cash flow to pay off debt; accounting profits just don't cut it. CoStar Group may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, CoStar Group generated free cash flow amounting to a very robust 80% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing Up

While it is always sensible to investigate a company's debt, in this case CoStar Group has US$3.96b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of US$2.4m, being 80% of its EBIT. So we are not troubled with CoStar Group's debt use. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - CoStar Group has 1 warning sign we think you should be aware of.

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.

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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com