There's no doubt that money can be made by owning shares of unprofitable businesses. For example, Diffusion Pharmaceuticals (NASDAQ:DFFN) shareholders have done very well over the last year, with the share price soaring by 123%. But the harsh reality is that very many loss making companies burn through all their cash and go bankrupt.
So notwithstanding the buoyant share price, we think it's well worth asking whether Diffusion Pharmaceuticals'cash burn is too risky In this report, we will consider the company's annual negative free cash flow, henceforth referring to it as the 'cash burn'. Let's start with an examination of the business' cash, relative to its cash burn.
How Long Is Diffusion Pharmaceuticals' Cash Runway?
A company's cash runway is calculated by dividing its cash hoard by its cash burn. In September 2020, Diffusion Pharmaceuticals had US$22m in cash, and was debt-free. In the last year, its cash burn was US$13m. That means it had a cash runway of around 21 months as of September 2020. 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. The image below shows how its cash balance has been changing over the last few years.
How Is Diffusion Pharmaceuticals' Cash Burn Changing Over Time?
Because Diffusion Pharmaceuticals isn't currently generating revenue, we consider it an early-stage business. Nonetheless, we can still examine its cash burn trajectory as part of our assessment of its cash burn situation. Over the last year its cash burn actually increased by 21%, which suggests that management are increasing investment in future growth, but not too quickly. However, the company's true cash runway will therefore be shorter than suggested above, if spending continues to increase. While the past is always worth studying, it is the future that matters most of all. For that reason, it makes a lot of sense to take a look at our analyst forecasts for the company.
How Easily Can Diffusion Pharmaceuticals Raise Cash?
Given its cash burn trajectory, Diffusion Pharmaceuticals shareholders may wish to consider how easily it could raise more cash, despite its solid cash runway. Companies can raise capital through either debt or equity. Commonly, a business will sell new shares in itself to raise cash and drive growth. We can compare a company's cash burn to its market capitalisation to get a sense for how many new shares a company would have to issue to fund one year's operations.
Since it has a market capitalisation of US$44m, Diffusion Pharmaceuticals' US$13m in cash burn equates to about 29% of its market value. That's not insignificant, and if the company had to sell enough shares to fund another year's growth at the current share price, you'd likely witness fairly costly dilution.
So, Should We Worry About Diffusion Pharmaceuticals' Cash Burn?
On this analysis of Diffusion Pharmaceuticals' cash burn, we think its cash runway was reassuring, while its cash burn relative to its market cap has us a bit worried. Even though we don't think it has a problem with its cash burn, the analysis we've done in this article does suggest that shareholders should give some careful thought to the potential cost of raising more money in the future. On another note, Diffusion Pharmaceuticals has 5 warning signs (and 2 which can't be ignored) we think you should know about.
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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What are the risks and opportunities for Diffusion Pharmaceuticals?
Makes less than USD$1m in revenue ($0)
Does not have a meaningful market cap ($13M)
Currently unprofitable and not forecast to become profitable over the next 3 years
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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