There's no doubt that money can be made by owning shares of unprofitable businesses. 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?
Given this risk, we thought we'd take a look at whether IRIDEX (NASDAQ:IRIX) shareholders should 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.
Does IRIDEX Have A Long Cash Runway?
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 June 2019, IRIDEX had cash of US$16m and no debt. Importantly, its cash burn was US$10m over the trailing twelve months. So it had a cash runway of approximately 18 months from June 2019. That's not too bad, but it's fair to say the end of the cash runway is in sight, unless cash burn reduces drastically. You can see how its cash balance has changed over time in the image below.
How Well Is IRIDEX Growing?
Some investors might find it troubling that IRIDEX is actually increasing its cash burn, which is up 26% in the last year. At least the revenue was up 7.1% during the period, even if it wasn't up by much. Considering both these factors, we're not particularly excited by its growth profile. While the past is always worth studying, it is the future that matters most of all. For that reason, it makes a lot of sense to take a look at our analyst forecasts for the company.
How Easily Can IRIDEX Raise Cash?
Even though it seems like IRIDEX is developing its business nicely, we still like to consider how easily it could raise more money to accelerate growth. Generally speaking, a listed business can raise new cash through issuing shares or taking on debt. 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.
IRIDEX has a market capitalisation of US$26m and burnt through US$10m last year, which is 40% of the company's market value. That's high expenditure relative to the value of the entire company, so if it does have to issue shares to fund more growth, that could end up really hurting shareholders returns (through significant dilution).
Is IRIDEX's Cash Burn A Worry?
On this analysis of IRIDEX's cash burn, we think its cash runway was reassuring, while its cash burn relative to its market cap has us a bit worried. Summing up, we think the IRIDEX's cash burn is a risk, based on the factors we mentioned in this article. While it's important to consider hard data like the metrics discussed above, many investors would also be interested to note that IRIDEX insiders have been trading shares in the company. Click here to find out if they have been buying or selling.
Of course IRIDEX 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.
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 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. Thank you for reading.