David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. Importantly, Watts Water Technologies, Inc. (NYSE:WTS) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Watts Water Technologies

What Is Watts Water Technologies's Debt?

You can click the graphic below for the historical numbers, but it shows that Watts Water Technologies had US$192.3m of debt in June 2021, down from US$264.4m, one year before. But it also has US$240.1m in cash to offset that, meaning it has US$47.8m net cash.

How Strong Is Watts Water Technologies' Balance Sheet?

According to the last reported balance sheet, Watts Water Technologies had liabilities of US$395.8m due within 12 months, and liabilities of US$341.6m due beyond 12 months. On the other hand, it had cash of US$240.1m and US$256.7m worth of receivables due within a year. So its liabilities total US$240.6m more than the combination of its cash and short-term receivables.

Since publicly traded Watts Water Technologies shares are worth a total of US$5.69b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Watts Water Technologies also has more cash than debt, so we're pretty confident it can manage its debt safely.

Also positive, Watts Water Technologies grew its EBIT by 30% in the last year, and that should make it easier to pay down debt, going forward. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Watts Water Technologies's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Watts Water Technologies 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 three years, Watts Water Technologies recorded free cash flow worth a fulsome 89% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Summing up

We could understand if investors are concerned about Watts Water Technologies's liabilities, but we can be reassured by the fact it has has net cash of US$47.8m. The cherry on top was that in converted 89% of that EBIT to free cash flow, bringing in US$222m. So we don't think Watts Water Technologies's use of debt is risky. 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. We've identified 1 warning sign with Watts Water Technologies , and understanding them should be part of your investment process.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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.

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