We can readily understand why investors are attracted to unprofitable companies. For example, although software-as-a-service business Salesforce.com lost money for years while it grew recurring revenue, if you held shares since 2005, you'd have done very well indeed. But the harsh reality is that very many loss making companies burn through all their cash and go bankrupt.
So, the natural question for PDF Solutions (NASDAQ:PDFS) shareholders is whether they should be concerned by its rate of 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.
When Might PDF Solutions Run Out Of Money?
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. In June 2019, PDF Solutions had US$87m in cash, and was debt-free. Importantly, its cash burn was US$3.8m over the trailing twelve months. That means it had a cash runway of very many years as of June 2019. While this is only one measure of its cash burn situation, it certainly gives us the impression that holders have nothing to worry about. The image below shows how its cash balance has been changing over the last few years.
Is PDF Solutions's Revenue Growing?
Given that PDF Solutions actually had positive free cash flow last year, before burning cash this year, we'll focus on its operating revenue to get a measure of the business trajectory. Unfortunately, the last year has been a disappointment, with operating revenue dropping 18% during the period. Clearly, however, the crucial factor is whether the company will grow its business going forward. For that reason, it makes a lot of sense to take a look at our analyst forecasts for the company.
Can PDF Solutions Raise More Cash Easily?
Since its revenue growth is moving in the wrong direction, PDF Solutions shareholders may wish to think ahead to when the company may need to raise more cash. 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 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).
PDF Solutions's cash burn of US$3.8m is about 0.8% of its US$461m market capitalisation. That means it could easily issue a few shares to fund more growth, and might well be in a position to borrow cheaply.
So, Should We Worry About PDF Solutions's Cash Burn?
It may already be apparent to you that we're relatively comfortable with the way PDF Solutions is burning through its cash. For example, we think its cash runway suggests that the company is on a good path. While its falling revenue wasn't great, the other factors mentioned in this article more than make up for weakness on that measure. Looking at all the measures in this article, together, we're not worried about its rate of cash burn; the company seems well on top of its medium-term spending needs. While it's important to consider hard data like the metrics discussed above, many investors would also be interested to note that PDF Solutions insiders have been trading shares in the company. Click here to find out if they have been buying or selling.
Of course PDF Solutions 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.
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