We can readily understand why investors are attracted to unprofitable companies. 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 the harsh reality is that very many loss making companies burn through all their cash and go bankrupt.
Given this risk, we thought we'd take a look at whether Star Diamond (TSE:DIAM) shareholders should be worried about its cash burn. In this report, we will consider the company's annual negative free cash flow, henceforth referring to it as the 'cash burn'. We'll start by comparing its cash burn with its cash reserves in order to calculate its cash runway.
How Long Is Star Diamond's Cash Runway?
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. When Star Diamond last reported its balance sheet in June 2019, it had zero debt and cash worth CA$4.0m. Looking at the last year, the company burnt through CA$2.5m. Therefore, from June 2019 it had roughly 19 months of cash runway. That's not too bad, but it's fair to say the end of the cash runway is in sight, unless cash burn reduces drastically. The image below shows how its cash balance has been changing over the last few years.
How Is Star Diamond's Cash Burn Changing Over Time?
Because Star Diamond isn't currently generating revenue, we consider it an early-stage business. Nonetheless, we can still examine its cash burn trajectory as part of our assessment of its cash burn situation. While it hardly paints a picture of imminent growth, the fact that it has reduced its cash burn by 43% over the last year suggests some degree of prudence. Admittedly, we're a bit cautious of Star Diamond due to its lack of significant operating revenues. We prefer most of the stocks on this list of stocks that analysts expect to grow.
How Easily Can Star Diamond Raise Cash?
Even though it has reduced its cash burn recently, shareholders should still consider how easy it would be for Star Diamond to raise more cash in the future. Companies can raise capital through either debt or equity. One of the main advantages held by publicly listed companies is that they can sell shares to investors to raise cash to fund 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$84m, Star Diamond's CA$2.5m in cash burn equates to about 3.0% of its market value. Given that is a rather small percentage, it would probably be really easy for the company to fund another year's growth by issuing some new shares to investors, or even by taking out a loan.
How Risky Is Star Diamond's Cash Burn Situation?
It may already be apparent to you that we're relatively comfortable with the way Star Diamond is burning through its cash. In particular, we think its cash burn relative to its market cap stands out as evidence that the company is well on top of its spending. Its cash runway wasn't quite as good, but was still rather encouraging! Based on the factors mentioned in this article, we think its cash burn situation warrants some attention from shareholders, but we don't think they should be worried. 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: Star Diamond 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)
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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.