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. By way of example, Datasea (NASDAQ:DTSS) has seen its share price rise 168% over the last year, delighting many shareholders. Nonetheless, only a fool would ignore the risk that a loss making company burns through its cash too quickly.
Given its strong share price performance, we think it's worthwhile for Datasea 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. We'll start by comparing its cash burn with its cash reserves in order to calculate its cash runway.
Does Datasea 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. In March 2020, Datasea had US$2.0m in cash, and was debt-free. Importantly, its cash burn was US$3.1m over the trailing twelve months. That means it had a cash runway of around 8 months as of March 2020. That's quite a short cash runway, indicating the company must either reduce its annual cash burn or replenish its cash. However, if we extrapolate the company's recent cash burn trend, then it would have a longer cash run way. Depicted below, you can see how its cash holdings have changed over time.
How Is Datasea's Cash Burn Changing Over Time?
Because Datasea 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. Over the last year its cash burn actually increased by a very significant 94%. 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 Datasea 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 Datasea To Raise More Cash For Growth?
Given its cash burn trajectory, Datasea shareholders should already be thinking about how easy it might be for it to raise further cash in the future. Issuing new shares, or taking on debt, are the most common ways for a listed company to raise more money for its business. Many companies end up issuing new shares to fund future 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.
Datasea has a market capitalisation of US$62m and burnt through US$3.1m last year, which is 5.0% of the company's market value. 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 Datasea's Cash Burn Situation?
Even though its increasing cash burn makes us a little nervous, we are compelled to mention that we thought Datasea's cash burn relative to its market cap was relatively promising. Looking at the factors mentioned in this short report, we do think that its cash burn is a bit risky, and it does make us slightly nervous about the stock. On another note, Datasea has 5 warning signs (and 2 which make us uncomfortable) we think you should know about.
If you would prefer to check out another company with better fundamentals, then do not miss this free list of interesting companies, that have HIGH return on equity and low debt or this list of stocks which are all forecast to grow.
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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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