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Is Ovid Therapeutics (NASDAQ:OVID) In A Good Position To Invest In Growth?

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Simply Wall St
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Even when a business is losing money, it's possible for shareholders to make money if they buy a good business at the right price. 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 Ovid Therapeutics (NASDAQ:OVID) 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. The first step is to compare its cash burn with its cash reserves, to give us its 'cash runway'.

Check out our latest analysis for Ovid Therapeutics

When Might Ovid Therapeutics Run Out Of Money?

A company's cash runway is calculated by dividing its cash hoard by its cash burn. As at September 2019, Ovid Therapeutics had cash of US$38m and no debt. Importantly, its cash burn was US$45m over the trailing twelve months. So it had a cash runway of approximately 10 months from September 2019. Notably, analysts forecast that Ovid Therapeutics will break even (at a free cash flow level) in about 4 years. That means unless the company reduces its cash burn quickly, it may well look to raise more cash. Depicted below, you can see how its cash holdings have changed over time.

NasdaqGS:OVID Historical Debt, January 10th 2020
NasdaqGS:OVID Historical Debt, January 10th 2020

How Is Ovid Therapeutics's Cash Burn Changing Over Time?

Ovid Therapeutics didn't record any revenue over the last year, indicating that it's an early stage company still developing its 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. Over the last year its cash burn actually increased by 3.1%, which suggests that management are increasing investment in future growth, but not too quickly. However, the company's true cash runway will therefore be shorter than suggested above, if spending continues to increase. Clearly, however, the crucial factor is whether the company will grow its business going forward. So you might want to take a peek at how much the company is expected to grow in the next few years.

How Hard Would It Be For Ovid Therapeutics To Raise More Cash For Growth?

Since its cash burn is increasing (albeit only slightly), Ovid Therapeutics shareholders should still be mindful of the possibility it will require more cash in the future. Generally speaking, a listed business can raise new cash through issuing shares or taking on debt. Many companies end up issuing new shares to fund future 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.

Ovid Therapeutics has a market capitalisation of US$194m and burnt through US$45m last year, which is 23% of the company's 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 Ovid Therapeutics's Cash Burn?

Ovid Therapeutics is not in a great position when it comes to its cash burn situation. While its increasing cash burn wasn't too bad, its cash runway does leave us rather nervous. One real positive is that analysts are forecasting that the company will reach breakeven. Summing up, we think the Ovid Therapeutics'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 Ovid Therapeutics insiders have been trading shares in the company. Click here to find out if they have been buying or selling.

Of course Ovid Therapeutics 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.