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Companies Like Power Metals (CVE:PWM) Can Be Considered Quite Risky

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There's no doubt that money can be made by owning shares of unprofitable businesses. For example, biotech and mining exploration companies often lose money for years before finding success with a new treatment or mineral discovery. Having said that, unprofitable companies are risky because they could potentially burn through all their cash and become distressed.

So should Power Metals (CVE:PWM) shareholders be worried about its cash burn? 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.

See our latest analysis for Power Metals

When Might Power Metals 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. As at May 2019, Power Metals had cash of CA$477k and no debt. Importantly, its cash burn was CA$2.9m over the trailing twelve months. Therefore, from May 2019 it had roughly 2 months of cash runway. It's extremely surprising to us that the company has allowed its cash runway to get that short! Depicted below, you can see how its cash holdings have changed over time.

TSXV:PWM Historical Debt, October 3rd 2019
TSXV:PWM Historical Debt, October 3rd 2019

How Is Power Metals's Cash Burn Changing Over Time?

Power Metals 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. Given the length of the cash runway, we'd interpret the 44% reduction in cash burn, in twelve months, as prudent if not necessary for capital preservation. Power Metals makes us a little nervous due to its lack of substantial operating revenue. So we'd generally prefer stocks from this list of stocks that have analysts forecasting growth.

Can Power Metals Raise More Cash Easily?

Even though it has reduced its cash burn recently, shareholders should still consider how easy it would be for Power Metals to raise more 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. 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.

Since it has a market capitalisation of CA$7.2m, Power Metals's CA$2.9m in cash burn equates to about 40% of its market value. That's fairly notable cash burn, so if the company had to sell shares to cover the cost of another year's operations, shareholders would suffer some costly dilution.

How Risky Is Power Metals's Cash Burn Situation?

There are no prizes for guessing that we think Power Metals's cash burn is a bit of a worry. In particular, we think its cash runway suggests it isn't in a good position to keep funding growth. On the other hand at least it could boast rather strong cash burn reduction, which no doubt gives shareholders some comfort. After considering the data discussed in this article, we don't have a lot of confidence that its cash burn rate is prudent, as it seems like it might need more cash soon. Notably, our data indicates that Power Metals insiders have been trading the shares. You can discover if they are buyers or sellers by clicking on this link.

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)

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.