We can readily understand why investors are attracted to unprofitable companies. 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 Ethernity Networks (LON:ENET) shareholders be worried about its 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). First, we'll determine its cash runway by comparing its cash burn with its cash reserves.
How Long Is Ethernity Networks's Cash Runway?
A cash runway is defined as the length of time it would take a company to run out of money if it kept spending at its current rate of cash burn. In June 2019, Ethernity Networks had US$5.9m in cash, and was debt-free. Looking at the last year, the company burnt through US$5.9m. Therefore, from June 2019 it had roughly 12 months of cash runway. 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. Depicted below, you can see how its cash holdings have changed over time.
How Well Is Ethernity Networks Growing?
At first glance it's a bit worrying to see that Ethernity Networks actually boosted its cash burn by 13%, year on year. But looking on the bright side, its revenue gained by 70%, lending some credence to the growth narrative. Of course, with spend going up shareholders will want to see fast growth continue. We think it is growing rather well, upon reflection. Of course, we've only taken a quick look at the stock's growth metrics, here. You can take a look at how Ethernity Networks is growing revenue over time by checking this visualization of past revenue growth.
How Easily Can Ethernity Networks Raise Cash?
Ethernity Networks seems to be in a fairly good position, in terms of cash burn, but we still think it's worthwhile considering how easily it could raise more money if it wanted to. Companies can raise capital through either debt or equity. Many companies end up issuing new shares to fund future growth. By comparing a company's annual cash burn to its total market capitalisation, we can estimate roughly how many shares it would have to issue in order to run the company for another year (at the same burn rate).
Ethernity Networks has a market capitalisation of US$19m and burnt through US$5.9m last year, which is 31% of the company's 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 Ethernity Networks's Cash Burn Situation?
On this analysis of Ethernity Networks's cash burn, we think its revenue growth 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. 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 Ethernity Networks'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)
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