The simplest way to benefit from a rising market is to buy an index fund. When you buy individual stocks, you can make higher profits, but you also face the risk of under-performance. Investors in Energy Metals Limited (ASX:EME) have tasted that bitter downside in the last year, as the share price dropped 29%. That's well bellow the market return of 13%. Energy Metals may have better days ahead, of course; we've only looked at a one year period. There was little comfort for shareholders in the last week as the price declined a further 11%.
With just AU$9,112 worth of revenue in twelve months, we don't think the market considers Energy Metals to have proven its business plan. You have to wonder why venture capitalists aren't funding it. As a result, we think it's unlikely shareholders are paying much attention to current revenue, but rather speculating on growth in the years to come. For example, they may be hoping that Energy Metals finds fossil fuels with an exploration program, before it runs out of money.
We think companies that have neither significant revenues nor profits are pretty high risk. There is usually a significant chance that they will need more money for business development, putting them at the mercy of capital markets. So the share price itself impacts the value of the shares (as it determines the cost of capital). While some such companies go on to make revenue, profits, and generate value, others get hyped up by hopeful naifs before eventually going bankrupt.
Energy Metals has plenty of cash in the bank, with cash in excess of all liabilities sitting at AU$17m, when it last reported (June 2019). This gives management the flexibility to drive business growth, without worrying too much about cash reserves. But since the share price has dropped 29% in the last year, it seems like the market might have been over-excited previously. The image below shows how Energy Metals's balance sheet has changed over time; if you want to see the precise values, simply click on the image. The image below shows how Energy Metals's balance sheet has changed over time; if you want to see the precise values, simply click on the image.
Of course, the truth is that it is hard to value companies without much revenue or profit. What if insiders are ditching the stock hand over fist? I'd like that just about as much as I like to drink milk and fruit juice mixed together. It only takes a moment for you to check whether we have identified any insider sales recently.
A Different Perspective
Investors in Energy Metals had a tough year, with a total loss of 29%, against a market gain of about 13%. Even the share prices of good stocks drop sometimes, but we want to see improvements in the fundamental metrics of a business, before getting too interested. Unfortunately, last year's performance may indicate unresolved challenges, given that it was worse than the annualised loss of 2.2% over the last half decade. Generally speaking long term share price weakness can be a bad sign, though contrarian investors might want to research the stock in hope of a turnaround. You could get a better understanding of Energy Metals's growth by checking out this more detailed historical graph of earnings, revenue and cash flow.
Of course Energy Metals may not be the best stock to buy. So you may wish to see this free collection of growth stocks.
Please note, the market returns quoted in this article reflect the market weighted average returns of stocks that currently trade on AU exchanges.
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 firstname.lastname@example.org. 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.