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Here's Why We're A Bit Worried About Margaret Lake Diamonds's (CVE:DIA) Cash Burn Situation

Simply Wall St

We can readily understand why investors are attracted to unprofitable companies. For example, although Amazon.com made losses for many years after listing, if you had bought and held the shares since 1999, you would have made a fortune. But while history lauds those rare successes, those that fail are often forgotten; who remembers Pets.com?

So should Margaret Lake Diamonds (CVE:DIA) shareholders be worried about its cash burn? In this article, we define cash burn as its annual (negative) free cash flow, which is the amount of money a company spends each year to fund its growth. First, we'll determine its cash runway by comparing its cash burn with its cash reserves.

See our latest analysis for Margaret Lake Diamonds

When Might Margaret Lake Diamonds Run Out Of Money?

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 November 2019, Margaret Lake Diamonds had CA$2.4k in cash, and was debt-free. Importantly, its cash burn was CA$703k over the trailing twelve months. That means it had a cash runway of under two months as of November 2019. To be frank we are alarmed by how short that cash runway is! You can see how its cash balance has changed over time in the image below.

TSXV:DIA Historical Debt, February 1st 2020

How Is Margaret Lake Diamonds's Cash Burn Changing Over Time?

Because Margaret Lake Diamonds 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. It's possible that the 18% reduction in cash burn over the last year is evidence of management tightening their belts as cash reserves deplete. Admittedly, we're a bit cautious of Margaret Lake Diamonds due to its lack of significant operating revenues. We prefer most of the stocks on this list of stocks that analysts expect to grow.

Can Margaret Lake Diamonds Raise More Cash Easily?

Even though it has reduced its cash burn recently, shareholders should still consider how easy it would be for Margaret Lake Diamonds to raise more cash in the future. Companies can raise capital through either debt or equity. One of the main advantages held by publicly listed companies is that they can sell shares to investors to raise cash to fund 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.

Since it has a market capitalisation of CA$2.2m, Margaret Lake Diamonds's CA$703k in cash burn equates to about 32% of its market value. That's not insignificant, and if the company had to sell enough shares to fund another year's growth at the current share price, you'd likely witness fairly costly dilution.

So, Should We Worry About Margaret Lake Diamonds's Cash Burn?

As you can probably tell by now, we're rather concerned about Margaret Lake Diamonds's cash burn. Take, for example, its cash runway, which suggests the company may have difficulty funding itself, in the future. And although we accept its cash burn reduction wasn't as worrying as its cash runway, it was still a real negative; as indeed were all the factors we considered in this article. Once we consider the metrics mentioned in this article together, we're left with very little confidence in the company's ability to manage its cash burn, and we think it will probably need more money. 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 Margaret Lake Diamonds's CEO gets paid each year.

Of course Margaret Lake Diamonds may not be the best stock to buy. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying.

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.

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. Thank you for reading.