Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Alkermes plc (NASDAQ:ALKS) does use debt in its business. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is Alkermes's Debt?

The chart below, which you can click on for greater detail, shows that Alkermes had US$288.8m in debt in September 2024; about the same as the year before. However, its balance sheet shows it holds US$908.9m in cash, so it actually has US$620.0m net cash.

How Healthy Is Alkermes' Balance Sheet?

We can see from the most recent balance sheet that Alkermes had liabilities of US$453.7m falling due within a year, and liabilities of US$409.5m due beyond that. On the other hand, it had cash of US$908.9m and US$370.2m worth of receivables due within a year. So it actually has US$415.9m more liquid assets than total liabilities.

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

In fact Alkermes's saving grace is its low debt levels, because its EBIT has tanked 33% 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 Alkermes'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Alkermes 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. During the last two years, Alkermes produced sturdy free cash flow equating to 72% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While it is always sensible to investigate a company's debt, in this case Alkermes has US$620.0m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of US$315m, being 72% of its EBIT. So we are not troubled with Alkermes's debt use. When analysing debt levels, the balance sheet is the obvious place to start. 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 1 warning sign for Alkermes 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.