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. Importantly, Methode Electronics, Inc. (NYSE:MEI) does carry debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. 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. 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.

How Much Debt Does Methode Electronics Carry?

The image below, which you can click on for greater detail, shows that Methode Electronics had debt of US$299.4m at the end of July 2024, a reduction from US$340.1m over a year. However, it does have US$111.3m in cash offsetting this, leading to net debt of about US$188.1m.

A Look At Methode Electronics' Liabilities

We can see from the most recent balance sheet that Methode Electronics had liabilities of US$260.8m falling due within a year, and liabilities of US$372.7m due beyond that. On the other hand, it had cash of US$111.3m and US$252.7m worth of receivables due within a year. So it has liabilities totalling US$269.5m more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of US$390.5m, so it does suggest shareholders should keep an eye on Methode Electronics' use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. 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 Methode Electronics can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Over 12 months, Methode Electronics made a loss at the EBIT level, and saw its revenue drop to US$1.1b, which is a fall of 8.7%. We would much prefer see growth.

Caveat Emptor

Over the last twelve months Methode Electronics produced an earnings before interest and tax (EBIT) loss. Indeed, it lost US$11m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. So we think its balance sheet is a little strained, though not beyond repair. For example, we would not want to see a repeat of last year's loss of US$143m. So we do think this stock is quite risky. 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 example, we've discovered 2 warning signs for Methode Electronics that you should be aware of before investing here.

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.