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There's no doubt that money can be made by owning shares of unprofitable businesses. Indeed, Defiance Silver (CVE:DEF) stock is up 195% in the last year, providing strong gains for shareholders. 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 notwithstanding the buoyant share price, we think it's well worth asking whether Defiance Silver's cash burn is too risky. For the purpose of this article, we'll define cash burn as the amount of cash the company is spending each year to fund its growth (also called its negative free cash flow). Let's start with an examination of the business' cash, relative to its cash burn.
When Might Defiance Silver Run Out Of Money?
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. As at September 2020, Defiance Silver had cash of CA$10m and no debt. Importantly, its cash burn was CA$2.7m over the trailing twelve months. So it had a cash runway of about 3.8 years from September 2020. A runway of this length affords the company the time and space it needs to develop the business. The image below shows how its cash balance has been changing over the last few years.
How Is Defiance Silver's Cash Burn Changing Over Time?
Because Defiance Silver isn't currently generating revenue, we consider it an early-stage 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. While it hardly paints a picture of imminent growth, the fact that it has reduced its cash burn by 22% over the last year suggests some degree of prudence. Defiance Silver makes us a little nervous due to its lack of substantial operating revenue. We prefer most of the stocks on this list of stocks that analysts expect to grow.
How Hard Would It Be For Defiance Silver To Raise More Cash For Growth?
Even though it has reduced its cash burn recently, shareholders should still consider how easy it would be for Defiance Silver to raise more cash in the future. Generally speaking, a listed business can raise new cash through issuing shares or taking on debt. 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.
Defiance Silver has a market capitalisation of CA$120m and burnt through CA$2.7m last year, which is 2.2% of the company's 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 Defiance Silver's Cash Burn A Worry?
As you can probably tell by now, we're not too worried about Defiance Silver's cash burn. For example, we think its cash runway suggests that the company is on a good path. Its cash burn reduction wasn't quite as good, but was still rather encouraging! Taking all the factors in this report into account, we're not at all worried about its cash burn, as the business appears well capitalized to spend as needs be. On another note, we conducted an in-depth investigation of the company, and identified 4 warning signs for Defiance Silver (1 is concerning!) that you should be aware of before investing here.
Of course Defiance Silver 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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