There's no doubt that money can be made by owning shares of unprofitable businesses. For example, Pacific Edge (NZSE:PEB) shareholders have done very well over the last year, with the share price soaring by 852%. Nonetheless, only a fool would ignore the risk that a loss making company burns through its cash too quickly.
So notwithstanding the buoyant share price, we think it's well worth asking whether Pacific Edge's cash burn is too risky. 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.
When Might Pacific Edge 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. When Pacific Edge last reported its balance sheet in March 2021, it had zero debt and cash worth NZ$23m. Importantly, its cash burn was NZ$14m over the trailing twelve months. So it had a cash runway of approximately 20 months from March 2021. While that cash runway isn't too concerning, sensible holders would be peering into the distance, and considering what happens if the company runs out of cash. Depicted below, you can see how its cash holdings have changed over time.
How Well Is Pacific Edge Growing?
Pacific Edge reduced its cash burn by 10% during the last year, which points to some degree of discipline. Having said that, the revenue growth of 76% was considerably more inspiring. We think it is growing rather well, upon reflection. While the past is always worth studying, it is the future that matters most of all. So you might want to take a peek at how much the company is expected to grow in the next few years.
How Easily Can Pacific Edge Raise Cash?
Pacific Edge seems to be in a fairly good position, in terms of cash burn, but we still think it's worthwhile considering how easily it could raise more money if it wanted to. Companies can raise capital through either debt or equity. 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).
Since it has a market capitalisation of NZ$859m, Pacific Edge's NZ$14m in cash burn equates to about 1.6% of its market value. That means it could easily issue a few shares to fund more growth, and might well be in a position to borrow cheaply.
How Risky Is Pacific Edge's Cash Burn Situation?
As you can probably tell by now, we're not too worried about Pacific Edge's cash burn. In particular, we think its revenue growth stands out as evidence that the company is well on top of its spending. Its weak point is its cash burn reduction, but even that wasn't too bad! 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. Readers need to have a sound understanding of business risks before investing in a stock, and we've spotted 2 warning signs for Pacific Edge that potential shareholders should take into account before putting money into a stock.
Of course, you might find a fantastic investment by looking elsewhere. So take a peek at this free list of interesting companies, and this list of stocks growth stocks (according to analyst forecasts)
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Pacific Edge Limited, a cancer diagnostic company, researches, develops, and commercializes diagnostic and prognostic tools for the early detection and management of cancers in New Zealand, the United States, Australia, and Singapore.
Flawless balance sheet with limited growth.