Just because a business does not make any money, does not mean that the stock will go down. For example, Aruma Resources (ASX:AAJ) shareholders have done very well over the last year, with the share price soaring by 133%. But the harsh reality is that very many loss making companies burn through all their cash and go bankrupt.
Given its strong share price performance, we think it's worthwhile for Aruma Resources shareholders to consider whether its cash burn is concerning. 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.
How Long Is Aruma Resources' Cash Runway?
A company's cash runway is calculated by dividing its cash hoard by its cash burn. In June 2020, Aruma Resources had AU$1.1m in cash, and was debt-free. Looking at the last year, the company burnt through AU$264k. That means it had a cash runway of about 4.3 years as of June 2020. A runway of this length affords the company the time and space it needs to develop the business. You can see how its cash balance has changed over time in the image below.
How Is Aruma Resources' Cash Burn Changing Over Time?
In our view, Aruma Resources doesn't yet produce significant amounts of operating revenue, since it reported just AU$615k in the last twelve months. Therefore, for the purposes of this analysis we'll focus on how the cash burn is tracking. The 76% reduction in its cash burn over the last twelve months may be good for protecting the balance sheet but it hardly points to imminent growth. Aruma Resources 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.
Can Aruma Resources Raise More Cash Easily?
There's no doubt Aruma Resources' rapidly reducing cash burn brings comfort, but even if it's only hypothetical, it's always worth asking how easily it could raise more money to fund further growth. 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$167m, Aruma Resources' AU$264k in cash burn equates to about 0.2% of its market value. So it could almost certainly just borrow a little to fund another year's growth, or else easily raise the cash by issuing a few shares.
Is Aruma Resources' Cash Burn A Worry?
As you can probably tell by now, we're not too worried about Aruma Resources' cash burn. In particular, we think its cash runway stands out as evidence that the company is well on top of its spending. And even its cash burn reduction was very encouraging. Looking at all the measures in this article, together, we're not worried about its rate of cash burn, which seems to be under control. Its important for readers to be cognizant of the risks that can affect the company's operations, and we've picked out 3 warning signs for Aruma Resources that investors should know when investing in the stock.
Of course Aruma Resources 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.
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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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