Companies Like Encounter Resources (ASX:ENR) Are In A Position To Invest In Growth

Just because a business does not make any money, does not mean that the stock will go down. By way of example, Encounter Resources (ASX:ENR) has seen its share price rise 300% over the last year, delighting many shareholders. Having said that, unprofitable companies are risky because they could potentially burn through all their cash and become distressed.

In light of its strong share price run, we think now is a good time to investigate how risky Encounter Resources' cash burn is. In this article, we define cash burn as its annual (negative) free cash flow, which is the amount of money a company spends each year to fund its growth. First, we'll determine its cash runway by comparing its cash burn with its cash reserves.

View our latest analysis for Encounter Resources

How Long Is Encounter Resources' Cash Runway?

A company's cash runway is calculated by dividing its cash hoard by its cash burn. As at December 2022, Encounter Resources had cash of AU$4.4m and no debt. In the last year, its cash burn was AU$3.0m. Therefore, from December 2022 it had roughly 18 months of cash runway. While that cash runway isn't too concerning, sensible holders would be peering into the distance, and considering what happens if the company runs out of cash. The image below shows how its cash balance has been changing over the last few years.

How Is Encounter Resources' Cash Burn Changing Over Time?

Encounter Resources 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. Even though it doesn't get us excited, the 42% reduction in cash burn year on year does suggest the company can continue operating for quite some time. Encounter Resources makes us a little nervous due to its lack of substantial operating revenue. So we'd generally prefer stocks from this list of stocks that have analysts forecasting growth.

Can Encounter Resources Raise More Cash Easily?

While Encounter Resources is showing a solid reduction in its cash burn, it's still worth considering how easily it could raise more cash, even just to fuel faster growth. Issuing new shares, or taking on debt, are the most common ways for a listed company to raise more money for its business. Commonly, a business will sell new shares in itself to raise cash and drive growth. By looking at a company's cash burn relative to its market capitalisation, we gain insight on how much shareholders would be diluted if the company needed to raise enough cash to cover another year's cash burn.

Encounter Resources has a market capitalisation of AU$190m and burnt through AU$3.0m last year, which is 1.6% of the company's market value. So it could almost certainly just borrow a little to fund another year's growth, or else easily raise the cash by issuing a few shares.

So, Should We Worry About Encounter Resources' Cash Burn?

It may already be apparent to you that we're relatively comfortable with the way Encounter Resources is burning through its cash. For example, we think its cash burn relative to its market cap suggests that the company is on a good path. On this analysis its cash runway was its weakest feature, but we are not concerned about it. Considering all the factors discussed in this article, we're not overly concerned about the company's cash burn, although we do think shareholders should keep an eye on how it develops. Taking a deeper dive, we've spotted 3 warning signs for Encounter Resources you should be aware of, and 2 of them shouldn't be ignored.

If you would prefer to check out another company with better fundamentals, then do not miss this free list of interesting companies, that have HIGH return on equity and low debt or this list of stocks which are all forecast to grow.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.