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Companies Like Alterity Therapeutics (ASX:ATH) Can Be Considered Quite Risky

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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, 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. But while the successes are well known, investors should not ignore the very many unprofitable companies that simply burn through all their cash and collapse.

So, the natural question for Alterity Therapeutics (ASX:ATH) shareholders is whether they should be concerned by its rate of cash burn. For the purpose of this article, we'll define cash burn as the amount of cash the company is spending each year to fund its growth (also called its negative free cash flow). The first step is to compare its cash burn with its cash reserves, to give us its 'cash runway'.

Check out our latest analysis for Alterity Therapeutics

When Might Alterity Therapeutics Run Out Of Money?

A company's cash runway is the amount of time it would take to burn through its cash reserves at its current cash burn rate. In June 2019, Alterity Therapeutics had AU$14m in cash, and was debt-free. In the last year, its cash burn was AU$14m. That means it had a cash runway of around 12 months as of June 2019. 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.

ASX:ATH Historical Debt, November 12th 2019
ASX:ATH Historical Debt, November 12th 2019

How Is Alterity Therapeutics's Cash Burn Changing Over Time?

While Alterity Therapeutics did record statutory revenue of AU$5.1m over the last year, it didn't have any revenue from operations. To us, that makes it a pre-revenue company, so we'll look to its cash burn trajectory as an assessment of its cash burn situation. The skyrocketing cash burn up 121% year on year certainly tests our nerves. That sort of spending growth rate can't continue for very long before it causes balance sheet weakness, generally speaking. Alterity Therapeutics makes us a little nervous due to its lack of substantial operating revenue. We prefer most of the stocks on this list of stocks that analysts expect to grow.

Can Alterity Therapeutics Raise More Cash Easily?

Given its cash burn trajectory, Alterity Therapeutics shareholders may wish to consider how easily it could raise more cash, despite its solid cash runway. Issuing new shares, or taking on debt, are the most common ways for a listed company to raise more money for its business. Commonly, a business will sell new shares in itself to raise cash to 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.

Alterity Therapeutics's cash burn of AU$14m is about 67% of its AU$21m market capitalisation. That's very high expenditure relative to the company's size, suggesting it is an extremely high risk stock.

How Risky Is Alterity Therapeutics's Cash Burn Situation?

On this analysis of Alterity Therapeutics's cash burn, we think its cash runway was reassuring, while its cash burn relative to its market cap has us a bit worried. After looking at that range of measures, we think shareholders should be extremely attentive to how the company is using its cash, as the cash burn makes us uncomfortable. 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 Alterity Therapeutics's CEO gets paid each year.

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)

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.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. Thank you for reading.