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Just because a business does not make any money, does not mean that the stock will go down. 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 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 should Discovery Africa (ASX:DAF) shareholders be worried about its 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. First, we'll determine its cash runway by comparing its cash burn with its cash reserves.
Check out our latest analysis for Discovery Africa
How Long Is Discovery Africa'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. As at June 2019, Discovery Africa had cash of AU$354k and no debt. Importantly, its cash burn was AU$569k over the trailing twelve months. So it had a cash runway of approximately 7 months from June 2019. That's quite a short cash runway, indicating the company must either reduce its annual cash burn or replenish its cash. The image below shows how its cash balance has been changing over the last few years.
How Is Discovery Africa's Cash Burn Changing Over Time?
In our view, Discovery Africa doesn't yet produce significant amounts of operating revenue, since it reported just AU$8.8k in the last twelve months. As a result, we think it's a bit early to focus on the revenue growth, so we'll limit ourselves to looking at how the cash burn is changing over time. It's possible that the 5.3% reduction in cash burn over the last year is evidence of management tightening their belts as cash reserves deplete. Discovery Africa 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 Discovery Africa Raise More Cash Easily?
Even though it has reduced its cash burn recently, shareholders should still consider how easy it would be for Discovery Africa to raise more cash in the future. Companies can raise capital through either debt or equity. 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.