Just because a business does not make any money, does not mean that the stock will go down. 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 while history lauds those rare successes, those that fail are often forgotten; who remembers Pets.com?
So should Red Light Holland (CSE:TRIP) 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. We'll start by comparing its cash burn with its cash reserves in order to calculate its cash runway.
Does Red Light Holland Have A Long Cash Runway?
A company's cash runway is calculated by dividing its cash hoard by its cash burn. As at September 2020, Red Light Holland had cash of CA$6.7m and no debt. Looking at the last year, the company burnt through CA$2.0m. Therefore, from September 2020 it had 3.4 years of cash runway. There's no doubt that this is a reassuringly long runway. The image below shows how its cash balance has been changing over the last few years.
How Is Red Light Holland's Cash Burn Changing Over Time?
Red Light Holland didn't record any revenue over the last year, indicating that it's an early stage company still developing its business. So while we can't look to sales to understand growth, we can look at how the cash burn is changing to understand how expenditure is trending over time. Remarkably, it actually increased its cash burn by 2,005% in the last year. Given that sharp increase in spending, the company's cash runway will shrink rapidly as it depletes its cash reserves. Admittedly, we're a bit cautious of Red Light Holland due to its lack of significant operating revenues. So we'd generally prefer stocks from this list of stocks that have analysts forecasting growth.
How Hard Would It Be For Red Light Holland To Raise More Cash For Growth?
While Red Light Holland 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. Generally speaking, a listed business can raise new cash through issuing shares or taking on debt. 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.
Red Light Holland's cash burn of CA$2.0m is about 7.2% of its CA$28m market capitalisation. 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 Red Light Holland's Cash Burn?
It may already be apparent to you that we're relatively comfortable with the way Red Light Holland is burning through its cash. For example, we think its cash runway 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. 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 4 warning signs for Red Light Holland you should be aware of, and 2 of them can'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.
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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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