Companies Like Peak Rare Earths (ASX:PEK) Are In A Position To Invest In Growth

We can readily understand why investors are attracted to unprofitable companies. For example, although software-as-a-service business Salesforce.com lost money for years while it grew recurring revenue, if you held shares since 2005, you'd have done very well indeed. But the harsh reality is that very many loss making companies burn through all their cash and go bankrupt.

So should Peak Rare Earths (ASX:PEK) shareholders be worried about its cash burn? For the purpose of this article, we'll define cash burn as the amount of cash the company is spending each year to fund its growth (also called its negative free cash flow). The first step is to compare its cash burn with its cash reserves, to give us its 'cash runway'.

See our latest analysis for Peak Rare Earths

Does Peak Rare Earths Have A Long Cash Runway?

You can calculate a company's cash runway by dividing the amount of cash it has by the rate at which it is spending that cash. In December 2021, Peak Rare Earths had AU$15m in cash, and was debt-free. Looking at the last year, the company burnt through AU$7.3m. Therefore, from December 2021 it had 2.0 years of cash runway. That's not too bad, but it's fair to say the end of the cash runway is in sight, unless cash burn reduces drastically. The image below shows how its cash balance has been changing over the last few years.

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

Peak 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 106%. That sort of spending growth rate can't continue for very long before it causes balance sheet weakness, generally speaking. Admittedly, we're a bit cautious of Peak 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 Hard Would It Be For Peak Rare Earths To Raise More Cash For Growth?

While Peak Rare Earths does have a solid cash runway, its cash burn trajectory may have some shareholders thinking ahead to when the company may need to raise more cash. 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. We can compare a company's cash burn to its market capitalisation to get a sense for how many new shares a company would have to issue to fund one year's operations.

Peak Rare Earths' cash burn of AU$7.3m is about 11% of its AU$69m market capitalisation. Given that situation, it's fair to say the company wouldn't have much trouble raising more cash for growth, but shareholders would be somewhat diluted.

How Risky Is Peak Rare Earths' Cash Burn Situation?

Even though its increasing cash burn makes us a little nervous, we are compelled to mention that we thought Peak Rare Earths' cash runway was relatively promising. While we're the kind of investors who are always a bit concerned about the risks involved with cash burning companies, the metrics we have discussed in this article leave us relatively comfortable about Peak Rare Earths' situation. On another note, Peak Rare Earths has 4 warning signs (and 1 which makes us a bit uncomfortable) we think you should know about.

Of course, you might find a fantastic investment by looking elsewhere. So take a peek at this free list of companies insiders are buying, and this list of stocks growth stocks (according to analyst forecasts)

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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.