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Can Sunstone Metals (ASX:STM) Afford To Invest In Growth?

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 Sunstone Metals (ASX:STM) 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. Let's start with an examination of the business's cash, relative to its cash burn.

See our latest analysis for Sunstone Metals

Does Sunstone Metals Have A Long Cash Runway?

A company's cash runway is calculated by dividing its cash hoard by its cash burn. As at June 2019, Sunstone Metals had cash of AU$1.9m and no debt. In the last year, its cash burn was AU$4.7m. That means it had a cash runway of around 5 months as of June 2019. That's a very short cash runway which indicates an imminent need to douse the cash burn or find more funding. Importantly, if we extrapolate recent cash burn trends, the cash runway would be a lot longer. The image below shows how its cash balance has been changing over the last few years.

ASX:STM Historical Debt, December 17th 2019
ASX:STM Historical Debt, December 17th 2019

How Is Sunstone Metals's Cash Burn Changing Over Time?

Whilst it's great to see that Sunstone Metals has already begun generating revenue from operations, last year it only produced AU$1.0k, so we don't think it is generating significant revenue, at this point. As a result, we think it's a bit early to focus on the revenue growth, so we'll limit ourselves to looking at how the cash burn is changing over time. As it happens, the company's cash burn reduced by 12% over the last year, which suggests that management may be mindful of the risks of their depleting cash reserves. Sunstone Metals makes us a little nervous due to its lack of substantial operating revenue. So we'd generally prefer stocks from this list of stocks that have analysts forecasting growth.

How Easily Can Sunstone Metals Raise Cash?

Even though it has reduced its cash burn recently, shareholders should still consider how easy it would be for Sunstone Metals to raise more cash in the future. 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. 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.

Since it has a market capitalisation of AU$22m, Sunstone Metals's AU$4.7m in cash burn equates to about 21% of its market value. That's fairly notable cash burn, so if the company had to sell shares to cover the cost of another year's operations, shareholders would suffer some costly dilution.

So, Should We Worry About Sunstone Metals's Cash Burn?

On this analysis of Sunstone Metals's cash burn, we think its cash burn reduction was reassuring, while its cash runway has us a bit worried. Considering all the measures mentioned in this report, we reckon that its cash burn is fairly risky, and if we held shares we'd be watching like a hawk for any deterioration. When you don't have traditional metrics like earnings per share and free cash flow to value a company, many are extra motivated to consider qualitative factors such as whether insiders are buying or selling shares. Please Note: Sunstone Metals insiders have been trading shares, according to our data. Click here to check whether insiders have been buying or selling.

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)

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.

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