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 the successes are well known, investors should not ignore the very many unprofitable companies that simply burn through all their cash and collapse.
Given this risk, we thought we'd take a look at whether Rockfire Resources (LON:ROCK) shareholders should be worried about its cash burn. For the purpose of this article, we'll define cash burn as the amount of cash the company is spending each year to fund its growth (also called its negative free cash flow). First, we'll determine its cash runway by comparing its cash burn with its cash reserves.
How Long Is Rockfire Resources's Cash Runway?
A company's cash runway is calculated by dividing its cash hoard by its cash burn. In June 2019, Rockfire Resources had UK£181k in cash, and was debt-free. Importantly, its cash burn was UK£1.1m over the trailing twelve months. That means it had a cash runway of around 2 months as of June 2019. 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 Is Rockfire Resources's Cash Burn Changing Over Time?
Rockfire Resources didn't record any revenue over the last year, indicating that it's an early stage company still developing its business. Nonetheless, we can still examine its cash burn trajectory as part of our assessment of its cash burn situation. 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. Admittedly, we're a bit cautious of Rockfire Resources due to its lack of significant operating revenues. So we'd generally prefer stocks from this list of stocks that have analysts forecasting growth.
How Hard Would It Be For Rockfire Resources To Raise More Cash For Growth?
While its cash burn is only increasing slightly, Rockfire Resources shareholders should still consider the potential need for further cash, down the track. Issuing new shares, or taking on debt, are the most common ways for a listed company to raise more money for its business. 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).
Since it has a market capitalisation of UK£1.8m, Rockfire Resources's UK£1.1m in cash burn equates to about 64% of its market value. Given how large that cash burn is, relative to the market value of the entire company, we'd consider it to be a high risk stock, with the real possibility of extreme dilution.
How Risky Is Rockfire Resources's Cash Burn Situation?
There are no prizes for guessing that we think Rockfire Resources's cash burn is a bit of a worry. Take, for example, its cash runway, which suggests the company may have difficulty funding itself, in the future. While not as bad as its cash runway, its increasing cash burn is also a concern, and considering everything mentioned above, we're struggling to find much to be optimistic about. The measures we've considered in this article lead us to believe its cash burn is actually quite concerning, and its weak cash position seems likely to cost shareholders one way or another. For us, it's always important to consider risks around cash burn rates. But investors should look at a whole range of factors when researching a new stock. For example, it could be interesting to see how much the Rockfire Resources CEO receives in total remuneration.
Of course, you might find a fantastic investment by looking elsewhere. So take a peek at this free list of companies insiders are buying, and this list of stocks growth stocks (according to analyst forecasts)
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If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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.