Companies Like Emerita Resources (CVE:EMO) Are In A Position To Invest In Growth

Even when a business is losing money, it's possible for shareholders to make money if they buy a good business at the right price. Indeed, Emerita Resources (CVE:EMO) stock is up 106% in the last year, providing strong gains for shareholders. Having said that, unprofitable companies are risky because they could potentially burn through all their cash and become distressed.

So notwithstanding the buoyant share price, we think it's well worth asking whether Emerita Resources' cash burn is too risky. 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). First, we'll determine its cash runway by comparing its cash burn with its cash reserves.

See our latest analysis for Emerita Resources

When Might Emerita Resources Run Out Of Money?

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. As at December 2021, Emerita Resources had cash of CA$28m and no debt. In the last year, its cash burn was CA$7.0m. Therefore, from December 2021 it had 4.0 years of cash runway. A runway of this length affords the company the time and space it needs to develop the business. You can see how its cash balance has changed over time in the image below.

How Is Emerita Resources' Cash Burn Changing Over Time?

Emerita Resources 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 267% in the last year. Given that sharp increase in spending, the company's cash runway will shrink rapidly as it depletes its cash reserves. Emerita 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.

How Hard Would It Be For Emerita Resources To Raise More Cash For Growth?

While Emerita Resources 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.

Emerita Resources has a market capitalisation of CA$276m and burnt through CA$7.0m last year, which is 2.5% 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.

How Risky Is Emerita Resources' Cash Burn Situation?

As you can probably tell by now, we're not too worried about Emerita Resources' cash burn. In particular, we think its cash runway stands out as evidence that the company is well on top of its spending. Although we do find its increasing cash burn to be a bit of a negative, once we consider the other metrics mentioned in this article together, the overall picture is one we are comfortable with. 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. On another note, we conducted an in-depth investigation of the company, and identified 4 warning signs for Emerita Resources (2 don't sit too well with us!) that you should be aware of before investing here.

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.