Here's Why We're Not Too Worried About American Rare Earths' (ASX:ARR) Cash Burn Situation

There's no doubt that money can be made by owning shares of unprofitable businesses. For example, although Amazon.com made losses for many years after listing, if you had bought and held the shares since 1999, you would have made a fortune. But while history lauds those rare successes, those that fail are often forgotten; who remembers Pets.com?

So should American Rare Earths (ASX:ARR) shareholders be worried about its cash burn? For the purposes of this article, cash burn is the annual rate at which an unprofitable company spends cash to fund its growth; its negative free cash flow. Let's start with an examination of the business' cash, relative to its cash burn.

Check out our latest analysis for American Rare Earths

Does American Rare Earths Have A Long Cash Runway?

A cash runway is defined as the length of time it would take a company to run out of money if it kept spending at its current rate of cash burn. As at December 2022, American Rare Earths had cash of AU$16m and no debt. Looking at the last year, the company burnt through AU$7.2m. So it had a cash runway of about 2.1 years from December 2022. That's decent, giving the company a couple years to develop its business. Depicted below, you can see how its cash holdings have changed over time.

How Is American Rare Earths' Cash Burn Changing Over Time?

American Rare Earths didn't record any revenue over the last year, indicating that it's an early stage company still developing its business. Nonetheless, we can still examine its cash burn trajectory as part of our assessment of its cash burn situation. In fact, it ramped its spending strongly over the last year, increasing cash burn by 138%. It's fair to say that sort of rate of increase cannot be maintained for very long, without putting pressure on the balance sheet. Admittedly, we're a bit cautious of American Rare Earths due to its lack of significant operating revenues. We prefer most of the stocks on this list of stocks that analysts expect to grow.

How Easily Can American Rare Earths Raise Cash?

Given its cash burn trajectory, American Rare Earths shareholders may wish to consider how easily it could raise more cash, despite its solid cash runway. Companies can raise capital through either debt or equity. Commonly, a business will sell new shares in itself to raise cash and drive growth. By comparing a company's annual cash burn to its total market capitalisation, we can estimate roughly how many shares it would have to issue in order to run the company for another year (at the same burn rate).

Since it has a market capitalisation of AU$100m, American Rare Earths' AU$7.2m in cash burn equates to about 7.2% of its market value. Given that is a rather small percentage, it would probably be really easy for the company to fund another year's growth by issuing some new shares to investors, or even by taking out a loan.

Is American Rare Earths' Cash Burn A Worry?

Even though its increasing cash burn makes us a little nervous, we are compelled to mention that we thought American Rare Earths' cash burn relative to its market cap was relatively promising. Cash burning companies are always on the riskier side of things, but after considering all of the factors discussed in this short piece, we're not too worried about its rate of cash burn. On another note, we conducted an in-depth investigation of the company, and identified 4 warning signs for American Rare Earths (2 are significant!) that you should be aware of before investing here.

Of course American Rare Earths may not be the best stock to buy. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying.

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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.