Just because a business does not make any money, does not mean that the stock will go down. For example, Red Metal (ASX:RDM) shareholders have done very well over the last year, with the share price soaring by 113%. 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 Red Metal's cash burn is. 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). Let's start with an examination of the business' cash, relative to its cash burn.
Does Red Metal Have A Long Cash Runway?
A company's cash runway is calculated by dividing its cash hoard by its cash burn. In December 2020, Red Metal had AU$3.5m in cash, and was debt-free. Looking at the last year, the company burnt through AU$783k. That means it had a cash runway of about 4.5 years as of December 2020. There's no doubt that this is a reassuringly long runway. You can see how its cash balance has changed over time in the image below.
How Well Is Red Metal Growing?
We reckon the fact that Red Metal managed to shrink its cash burn by 28% over the last year is rather encouraging. But the operating revenue growth of 204% was even better. It seems to be growing nicely. Of course, we've only taken a quick look at the stock's growth metrics, here. You can take a look at how Red Metal is growing revenue over time by checking this visualization of past revenue growth.
How Hard Would It Be For Red Metal To Raise More Cash For Growth?
There's no doubt Red Metal seems to be in a fairly good position, when it comes to managing its cash burn, but even if it's only hypothetical, it's always worth asking how easily it could raise more money to fund growth. Issuing new shares, or taking on debt, are the most common ways for a listed company to raise more money for its business. One of the main advantages held by publicly listed companies is that they can sell shares to investors to raise cash and fund 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).
Red Metal's cash burn of AU$783k is about 1.8% of its AU$43m market capitalisation. That means it could easily issue a few shares to fund more growth, and might well be in a position to borrow cheaply.
So, Should We Worry About Red Metal's Cash Burn?
It may already be apparent to you that we're relatively comfortable with the way Red Metal is burning through its cash. For example, we think its revenue growth suggests that the company is on a good path. Its cash burn reduction wasn't quite as good, but was still rather encouraging! After taking into account the various metrics mentioned in this report, we're pretty comfortable with how the company is spending its cash. Readers need to have a sound understanding of business risks before investing in a stock, and we've spotted 4 warning signs for Red Metal that potential shareholders should take into account before putting money into a stock.
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. 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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