Companies Like Clarity Pharmaceuticals (ASX:CU6) Are In A Position To Invest In Growth

We can readily understand why investors are attracted to unprofitable companies. For example, Clarity Pharmaceuticals (ASX:CU6) shareholders have done very well over the last year, with the share price soaring by 115%. But the harsh reality is that very many loss making companies burn through all their cash and go bankrupt.

Given its strong share price performance, we think it's worthwhile for Clarity Pharmaceuticals shareholders to consider whether its cash burn is concerning. 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.

Check out our latest analysis for Clarity Pharmaceuticals

Does Clarity Pharmaceuticals Have A Long Cash Runway?

A company's cash runway is the amount of time it would take to burn through its cash reserves at its current cash burn rate. As at June 2023, Clarity Pharmaceuticals had cash of AU$65m and no debt. Looking at the last year, the company burnt through AU$28m. Therefore, from June 2023 it had 2.4 years of cash runway. Notably, however, analysts think that Clarity Pharmaceuticals will break even (at a free cash flow level) before then. In that case, it may never reach the end of its cash runway. Depicted below, you can see how its cash holdings have changed over time.

How Is Clarity Pharmaceuticals' Cash Burn Changing Over Time?

While Clarity Pharmaceuticals did record statutory revenue of AU$9.8m over the last year, it didn't have any revenue from operations. That means we consider it a pre-revenue business, and we will focus our growth analysis on cash burn, for now. In fact, it ramped its spending strongly over the last year, increasing cash burn by 104%. That sort of spending growth rate can't continue for very long before it causes balance sheet weakness, generally speaking. Clearly, however, the crucial factor is whether the company will grow its business going forward. So you might want to take a peek at how much the company is expected to grow in the next few years.

How Hard Would It Be For Clarity Pharmaceuticals To Raise More Cash For Growth?

While Clarity Pharmaceuticals 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. 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.

Clarity Pharmaceuticals has a market capitalisation of AU$498m and burnt through AU$28m last year, which is 5.5% of the company's 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.

So, Should We Worry About Clarity Pharmaceuticals' Cash Burn?

It may already be apparent to you that we're relatively comfortable with the way Clarity Pharmaceuticals 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. While we must concede that its increasing cash burn is a bit worrying, the other factors mentioned in this article provide great comfort when it comes to the cash burn. One real positive is that analysts are forecasting that the company will reach breakeven. After taking into account the various metrics mentioned in this report, we're pretty comfortable with how the company is spending its cash, as it seems on track to meet its needs over the medium term. Taking an in-depth view of risks, we've identified 1 warning sign for Clarity Pharmaceuticals that you should be aware of before investing.

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.

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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.