Can Emmerson (LON:EML) Afford 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. For example, biotech and mining exploration companies often lose money for years before finding success with a new treatment or mineral discovery. But the harsh reality is that very many loss making companies burn through all their cash and go bankrupt.

So should Emmerson (LON:EML) shareholders be worried about its cash burn? In this article, we define cash burn as its annual (negative) free cash flow, which is the amount of money a company spends each year to fund its growth. Let's start with an examination of the business' cash, relative to its cash burn.

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How Long Is Emmerson's Cash Runway?

A company's cash runway is calculated by dividing its cash hoard by its cash burn. In June 2022, Emmerson had US$4.5m in cash, and was debt-free. In the last year, its cash burn was US$7.8m. Therefore, from June 2022 it had roughly 7 months of cash runway. That's quite a short cash runway, indicating the company must either reduce its annual cash burn or replenish its cash. The image below shows how its cash balance has been changing over the last few years.

How Is Emmerson's Cash Burn Changing Over Time?

Emmerson 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. Over the last year its cash burn actually increased by a very significant 95%. While this spending increase is no doubt intended to drive growth, if the trend continues the company's cash runway will shrink very quickly. Admittedly, we're a bit cautious of Emmerson 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 Emmerson To Raise More Cash For Growth?

Given its cash burn trajectory, Emmerson shareholders should already be thinking about how easy it might be for it to raise further cash in the future. 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.

Emmerson's cash burn of US$7.8m is about 15% of its US$53m market capitalisation. As a result, we'd venture that the company could raise more cash for growth without much trouble, albeit at the cost of some dilution.

So, Should We Worry About Emmerson's Cash Burn?

Even though its cash runway makes us a little nervous, we are compelled to mention that we thought Emmerson's cash burn relative to its market cap was relatively promising. Considering all the measures mentioned in this report, we reckon that its cash burn is fairly risky, and if we held shares we'd be watching like a hawk for any deterioration. On another note, Emmerson has 5 warning signs (and 3 which are potentially serious) we think you should know about.

Of course Emmerson 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. 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.