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There's no doubt that money can be made by owning shares of unprofitable businesses. For example, biotech and mining exploration companies often lose money for years before finding success with a new treatment or mineral discovery. 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.
So, the natural question for ARCA biopharma (NASDAQ:ABIO) shareholders is whether they should be concerned by its rate of cash burn. For the purposes of this article, cash burn is the annual rate at which an unprofitable company spends cash to fund its growth; its negative free cash flow. The first step is to compare its cash burn with its cash reserves, to give us its 'cash runway'.
Does ARCA biopharma Have A Long Cash Runway?
You can calculate a company's cash runway by dividing the amount of cash it has by the rate at which it is spending that cash. ARCA biopharma has such a small amount of debt that we'll set it aside, and focus on the US$51m in cash it held at September 2020. Looking at the last year, the company burnt through US$5.9m. Therefore, from September 2020 it had 8.7 years of cash runway. While this is only one measure of its cash burn situation, it certainly gives us the impression that holders have nothing to worry about. The image below shows how its cash balance has been changing over the last few years.
How Is ARCA biopharma's Cash Burn Changing Over Time?
Because ARCA biopharma 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. With the cash burn rate up 18% in the last year, it seems that the company is ratcheting up investment in the business over time. That's not necessarily a bad thing, but investors should be mindful of the fact that will shorten the cash runway. ARCA biopharma 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 Hard Would It Be For ARCA biopharma To Raise More Cash For Growth?
While ARCA biopharma does have a solid cash runway, its cash burn trajectory may have some shareholders thinking ahead to when the company may need to raise more cash. 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 and fund growth. By looking at a company's cash burn relative to its market capitalisation, we gain insight on how much shareholders would be diluted if the company needed to raise enough cash to cover another year's cash burn.
ARCA biopharma's cash burn of US$5.9m is about 12% of its US$48m market capitalisation. As a result, we'd venture that the company could raise more cash for growth without much trouble, albeit at the cost of some dilution.
So, Should We Worry About ARCA biopharma's Cash Burn?
It may already be apparent to you that we're relatively comfortable with the way ARCA biopharma is burning through its cash. In particular, we think its cash runway stands out as evidence that the company is well on top of its spending. While its increasing cash burn wasn't great, the other factors mentioned in this article more than make up for weakness on that measure. After taking into account the various metrics mentioned in this report, we're pretty comfortable with how the company is spending its cash, as it seems on track to meet its needs over the medium term. Taking a deeper dive, we've spotted 3 warning signs for ARCA biopharma you should be aware of, and 1 of them is potentially serious.
If you would prefer to check out another company with better fundamentals, then do not miss this free list of interesting companies, that have HIGH return on equity and low debt or this list of stocks which are all forecast to grow.
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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