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. Having said that, unprofitable companies are risky because they could potentially burn through all their cash and become distressed.
Given this risk, we thought we'd take a look at whether Eastwood Bio-Medical Canada (CVE:EBM) shareholders should 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. Let's start with an examination of the business's cash, relative to its cash burn.
Does Eastwood Bio-Medical Canada Have A Long Cash Runway?
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 October 2019, Eastwood Bio-Medical Canada had cash of CA$625k and no debt. Importantly, its cash burn was CA$201k over the trailing twelve months. So it had a cash runway of about 3.1 years from October 2019. 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 Eastwood Bio-Medical Canada's Cash Burn Changing Over Time?
Whilst it's great to see that Eastwood Bio-Medical Canada has already begun generating revenue from operations, last year it only produced CA$1.3m, so we don't think it is generating significant revenue, at this point. Therefore, for the purposes of this analysis we'll focus on how the cash burn is tracking. The 56% reduction in its cash burn over the last twelve months may be good for protecting the balance sheet but it hardly points to imminent growth. Eastwood Bio-Medical Canada 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 Eastwood Bio-Medical Canada To Raise More Cash For Growth?
There's no doubt Eastwood Bio-Medical Canada's rapidly reducing cash burn brings comfort, but even if it's only hypothetical, it's always worth asking how easily it could raise more money to fund further growth. Generally speaking, a listed business can raise new cash through issuing shares or taking on debt. Many companies end up issuing new shares to fund future 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).
Eastwood Bio-Medical Canada has a market capitalisation of CA$138m and burnt through CA$201k last year, which is 0.1% 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 Eastwood Bio-Medical Canada's Cash Burn Situation?
It may already be apparent to you that we're relatively comfortable with the way Eastwood Bio-Medical Canada is burning through its cash. In particular, we think its cash runway stands out as evidence that the company is well on top of its spending. And even its cash burn reduction was very encouraging. Looking at all the measures in this article, together, we're not worried about its rate of cash burn, which seems to be under control. We think it's very important to consider the cash burn for loss making companies, but other considerations such as the amount the CEO is paid can also enhance your understanding of the business. You can click here to see what Eastwood Bio-Medical Canada's CEO gets paid each year.
Of course Eastwood Bio-Medical Canada 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.
If you spot an error that warrants correction, please contact the editor at email@example.com. 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. Simply Wall St has no position in the stocks mentioned.
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