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There's no doubt that money can be made by owning shares of unprofitable businesses. For example, Northern Graphite (CVE:NGC) shareholders have done very well over the last year, with the share price soaring by 182%. But the harsh reality is that very many loss making companies burn through all their cash and go bankrupt.
In light of its strong share price run, we think now is a good time to investigate how risky Northern Graphite's cash burn is. 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 Northern Graphite Have A Long Cash Runway?
A company's cash runway is calculated by dividing its cash hoard by its cash burn. In March 2021, Northern Graphite had CA$5.5m in cash, and was debt-free. Importantly, its cash burn was CA$819k over the trailing twelve months. Therefore, from March 2021 it had 6.7 years of cash runway. Even though this is but one measure of the company's cash burn, the thought of such a long cash runway warms our bellies in a comforting way. You can see how its cash balance has changed over time in the image below.
How Is Northern Graphite's Cash Burn Changing Over Time?
Northern Graphite 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. With cash burn dropping by 13% it seems management feel the company is spending enough to advance its business plans at an appropriate pace. Admittedly, we're a bit cautious of Northern Graphite 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 Hard Would It Be For Northern Graphite To Raise More Cash For Growth?
While Northern Graphite is showing a solid reduction in its cash burn, it's still worth considering how easily it could raise more cash, even just to fuel faster growth. 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.
Northern Graphite's cash burn of CA$819k is about 2.2% of its CA$38m market capitalisation. That means it could easily issue a few shares to fund more growth, and might well be in a position to borrow cheaply.
So, Should We Worry About Northern Graphite's Cash Burn?
It may already be apparent to you that we're relatively comfortable with the way Northern Graphite 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. Its weak point is its cash burn reduction, but even that wasn't too bad! Looking at all the measures in this article, together, we're not worried about its rate of cash burn; the company seems well on top of its medium-term spending needs. Taking an in-depth view of risks, we've identified 2 warning signs for Northern Graphite that you should be aware of before investing.
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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