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. 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 ChongHerr Investments (ASX:CDH) shareholders is whether they should be concerned by its rate of 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. The first step is to compare its cash burn with its cash reserves, to give us its 'cash runway'.
Does ChongHerr Investments Have A Long Cash Runway?
You can calculate a company's cash runway by dividing the amount of cash it has by the rate at which it is spending that cash. When ChongHerr Investments last reported its balance sheet in December 2019, it had zero debt and cash worth AU$1.4k. Looking at the last year, the company burnt through AU$166k. Therefore, from December 2019 it seems to us it had less than two 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.
How Easily Can ChongHerr Investments Raise Cash?
Generally speaking, a listed business can raise new cash through issuing shares or taking on debt. 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.
ChongHerr Investments has a market capitalisation of AU$1.3m and burnt through AU$166k last year, which is 13% of the company's market value. Given that situation, it's fair to say the company wouldn't have much trouble raising more cash for growth, but shareholders would be somewhat diluted.
How Risky Is ChongHerr Investments's Cash Burn Situation?
Given it's an early stage company, we don't have a lot of data with which to judge ChongHerr Investments's cash burn. However, it is fair to say that its cash runway made us nervous. But in truth it seems to us that the company is burning cash rather quickly, which can create a need for costly capital raising. On another note, ChongHerr Investments has 5 warning signs (and 4 which don't sit too well with us) we think you should know about.
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)
If you spot an error that warrants correction, please contact the editor at email@example.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.
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