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. For example, Algernon Pharmaceuticals (CSE:AGN) shareholders have done very well over the last year, with the share price soaring by 130%. Having said that, unprofitable companies are risky because they could potentially burn through all their cash and become distressed.
Given its strong share price performance, we think it's worthwhile for Algernon Pharmaceuticals shareholders to consider whether its cash burn is concerning. 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. The first step is to compare its cash burn with its cash reserves, to give us its 'cash runway'.
When Might Algernon Pharmaceuticals Run Out Of Money?
A company's cash runway is calculated by dividing its cash hoard by its cash burn. When Algernon Pharmaceuticals last reported its balance sheet in May 2020, it had zero debt and cash worth CA$8.4m. Looking at the last year, the company burnt through CA$3.7m. Therefore, from May 2020 it had 2.2 years of cash runway. That's decent, giving the company a couple years to develop its business. The image below shows how its cash balance has been changing over the last few years.
How Is Algernon Pharmaceuticals' Cash Burn Changing Over Time?
Because Algernon Pharmaceuticals isn't currently generating revenue, we consider it an early-stage 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. In fact, it ramped its spending strongly over the last year, increasing cash burn by 124%. 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 Algernon Pharmaceuticals due to its lack of significant operating revenues. So we'd generally prefer stocks from this list of stocks that have analysts forecasting growth.
Can Algernon Pharmaceuticals Raise More Cash Easily?
While Algernon 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. Companies can raise capital through either debt or equity. 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.
Algernon Pharmaceuticals' cash burn of CA$3.7m is about 8.9% of its CA$42m 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.
How Risky Is Algernon Pharmaceuticals' Cash Burn Situation?
Even though its increasing cash burn makes us a little nervous, we are compelled to mention that we thought Algernon Pharmaceuticals' 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 Algernon Pharmaceuticals' situation. Taking a deeper dive, we've spotted 3 warning signs for Algernon Pharmaceuticals you should be aware of, and 1 of them is a bit concerning.
Of course Algernon Pharmaceuticals may not be the best stock to buy. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying.
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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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