Even when a business is losing money, it's possible for shareholders to make money if they buy a good business at the right price. For example, Encounter Resources (ASX:ENR) shareholders have done very well over the last year, with the share price soaring by 165%. But while history lauds those rare successes, those that fail are often forgotten; who remembers Pets.com?
In light of its strong share price run, we think now is a good time to investigate how risky Encounter Resources' 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'.
Check out our latest analysis for Encounter Resources
When Might Encounter Resources Run Out Of Money?
A cash runway is defined as the length of time it would take a company to run out of money if it kept spending at its current rate of cash burn. When Encounter Resources last reported its balance sheet in June 2023, it had zero debt and cash worth AU$12m. Looking at the last year, the company burnt through AU$4.3m. That means it had a cash runway of about 2.8 years as of June 2023. That's decent, giving the company a couple years to develop its business. Importantly, if we extrapolate recent cash burn trends, the cash runway would be a lot longer. Depicted below, you can see how its cash holdings have changed over time.
How Is Encounter Resources' Cash Burn Changing Over Time?
Although Encounter Resources reported revenue of AU$135 last year, it didn't actually have any revenue from operations. That means we consider it a pre-revenue business, and we will focus our growth analysis on cash burn, for now. Over the last year its cash burn actually increased by 13%, which suggests that management are increasing investment in future growth, but not too quickly. That's not necessarily a bad thing, but investors should be mindful of the fact that will shorten the cash runway. Admittedly, we're a bit cautious of Encounter Resources due to its lack of significant operating revenues. So we'd generally prefer stocks from this list of stocks that have analysts forecasting growth.
Can Encounter Resources Raise More Cash Easily?
While Encounter Resources 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. Issuing new shares, or taking on debt, are the most common ways for a listed company to raise more money for its business. Commonly, a business will sell new shares in itself to raise cash and drive 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.