Just because a business does not make any money, does not mean that the stock will go down. Indeed, Affinity Metals (CVE:AFF) stock is up 217% in the last year, providing strong gains for shareholders. Having said that, unprofitable companies are risky because they could potentially burn through all their cash and become distressed.
So notwithstanding the buoyant share price, we think it's well worth asking whether Affinity Metals's cash burn is too risky 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. We'll start by comparing its cash burn with its cash reserves in order to calculate its cash runway.
Does Affinity Metals Have A Long Cash Runway?
A cash runway is defined as the length of time it would take a company to run out of money if it kept spending at its current rate of cash burn. As at September 2019, Affinity Metals had cash of CA$325k and such minimal debt that we can ignore it for the purposes of this analysis. Looking at the last year, the company burnt through CA$552k. That means it had a cash runway of around 7 months as of September 2019. To be frank, this kind of short runway puts us on edge, as it indicates the company must reduce its cash burn significantly, or else raise cash imminently. Depicted below, you can see how its cash holdings have changed over time.
How Is Affinity Metals's Cash Burn Changing Over Time?
Affinity Metals 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. In fact, it ramped its spending strongly over the last year, increasing cash burn by 140%. That sort of spending growth rate can't continue for very long before it causes balance sheet weakness, generally speaking. Admittedly, we're a bit cautious of Affinity Metals due to its lack of significant operating revenues. So we'd generally prefer stocks from this list of stocks that have analysts forecasting growth.
Can Affinity Metals Raise More Cash Easily?
Given its cash burn trajectory, Affinity Metals shareholders should already be thinking about how easy it might be for it to raise further 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. 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 CA$5.9m, Affinity Metals's CA$552k in cash burn equates to about 9.3% of its market value. That's a low proportion, so we figure the company would be able to raise more cash to fund growth, with a little dilution, or even to simply borrow some money.
So, Should We Worry About Affinity Metals's Cash Burn?
On this analysis of Affinity Metals's cash burn, we think its cash burn relative to its market cap was reassuring, while its increasing cash burn has us a bit worried. Summing up, we think the Affinity Metals'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 Affinity Metals insiders have been trading shares in the company. Click here to find out if they 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 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.
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