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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that PulteGroup, Inc. (NYSE:PHM) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

What Is PulteGroup's Net Debt?

As you can see below, PulteGroup had US$2.16b of debt at September 2024, down from US$2.42b a year prior. However, it does have US$1.40b in cash offsetting this, leading to net debt of about US$758.9m.

A Look At PulteGroup's Liabilities

The latest balance sheet data shows that PulteGroup had liabilities of US$2.69b due within a year, and liabilities of US$2.70b falling due after that. On the other hand, it had cash of US$1.40b and US$236.1m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$3.75b.

Since publicly traded PulteGroup shares are worth a very impressive total of US$26.4b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

PulteGroup has net debt of just 0.20 times EBITDA, suggesting it could ramp leverage without breaking a sweat. And remarkably, despite having net debt, it actually received more in interest over the last twelve months than it had to pay. So there's no doubt this company can take on debt while staying cool as a cucumber. Fortunately, PulteGroup grew its EBIT by 2.4% in the last year, making that debt load look even more manageable. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if PulteGroup 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. In the last three years, PulteGroup's free cash flow amounted to 39% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

PulteGroup's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And the good news does not stop there, as its net debt to EBITDA also supports that impression! Looking at all the aforementioned factors together, it strikes us that PulteGroup can handle its debt fairly comfortably. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for PulteGroup (of which 1 makes us a bit uncomfortable!) you should know about.

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.