Login | October 23, 2020

Cash burn rate

Ask the Fool

Published: October 15, 2020

Q. Can you explain what a "burn rate" is? -- H.D., Madison, Mississippi
A. A company's burn rate reflects how rapidly it's burning through cash. It's generally not a concern with big, established businesses, but startup companies rely heavily on cash to survive. So it's worth looking into the burn rate of any smaller, fast-growing companies you're interested in -- and any company that's struggling.
New and growing companies are often unprofitable in their early years, but losing too much too fast can be fatal. Imagine that Big Bangs Salon (ticker: BZNGA) reported negative $100 million in free cash flow in its latest quarterly report, with its cash balance falling from $300 million to $200 million. With a burn rate of $100 million per quarter, it's likely to run out of cash in a few quarters. It will need to generate more cash -- perhaps by serving more customers, issuing more stock or taking on debt -- and/or cut spending, which could slow its growth.
Q. A stock I own has been dropping. Should I buy more shares now that they're priced lower? -- P.L., Cerritos, California
A. You're describing "averaging down," where you shrink the average price you paid for your shares by buying more at lower prices. That's sometimes effective -- such as if the entire market has swooned, taking your holding down with it through no fault of its own -- or if the market seems to have overreacted to some development concerning the company. Buying more of a fallen stock can be a big mistake, though, if the stock has been dropping for good reason and is not likely to recover anytime soon. Before buying, take an extra close look at the company.
Fool's School
Quarterly Work for Investors
If you choose to invest in individual companies (as opposed to, say, investing in a simple, low-fee, broad-market index fund), you can't just "set it and forget it." If you're aiming for the best performance results, you'll need to keep up with your holdings -- ideally, at least quarterly.
Most publicly traded American businesses issue a detailed "10-K" report every year. At the end of three other quarters, they issue shorter (but still informative) "10-Q" reports. Both 10-K and 10-Q reports will typically feature a set of financial statements: a balance sheet, income statement and statement of cash flow. A close look at these will reveal profit margins, cash position, debt loads, inventory levels and more. Together, these tell you how well each company is (or isn't) growing.
Along with the release of each quarterly report, many companies' managers hold conference calls with Wall Street analysts. You'll usually be able to access these via company websites, and an online search might even turn up transcripts of these calls. You can also find fellow investors discussing companies of interest on online discussion boards.
The release of a company's quarterly report is a good time to check up on it. At a minimum, read the report and do a search for any news related to the company to see what it's up to. (You'll find articles on many companies at Fool.com and elsewhere.) Ask yourself: Is the company doing well or poorly? What are its challenges and opportunities? Is it going in any new directions? Are there any red flags or troubling trends in the financial statements? Do I still believe in the company's future, and should I hold on? Is it still one of my best investment ideas?
If the financial statements have you flummoxed, learn how to make sense of them. Try "Reading Financial Reports for Dummies" by Lita Epstein (For Dummies, $25) or "Financial Statements: A Step-by-Step Guide to Understanding and Creating Financial Reports" by Thomas R. Ittelson (Career Press, $18).
Keeping up with your holdings can help you avoid unpleasant surprises.
My Dumbest Investment
Investments to Avoid
My dumbest investment occurred during my first week of investing: I lost my entire two-week paycheck in less than five minutes trying to day-trade shares of Direxion Daily Gold Miners Index Bear 2X, an apparently risky exchange-traded fund (ETF). -- D.L., online
The Fool responds: Fortunately, most ETFs aren't nearly as risky as that one. A typical ETF tracks either a market index, such as the S&P 500 or the Bloomberg Barclays U.S. Aggregate Bond index, or a category of securities, such as dividend-paying stocks, small-cap stocks or Latin American stocks. Certain ETFs, though, aim to deliver some multiple of the performance of a particular index; these are known as leveraged ETFs. Inverse (sometimes called "leveraged inverse") ETFs hope to deliver the opposite of an index's return. These ETFs use swaps, futures or derivatives -- essentially, securities that few people understand -- and they often don't meet their performance goals.
Your leveraged inverse ETF tracked the NYSE Arca Gold Miners Index, so if that index fell by 10%, you'd gain twice that -- 20%. If it rose 10%, you'd lose 20%. These ETFs are only meant to be very short-term investments: They reset themselves every day, and can wipe out those trying to buy and hold them. Most of us should just steer clear of 2X ("Ultra"), 3X and 4X funds. Learn more by using Google to search "leveraged ETF site:SEC.gov."
Foolish Trivia
Name That Company
I trace my roots back to 1967, when a pathology resident borrowed $500 from his father-in-law and founded Metropolitan Pathology Laboratories, performing outpatient testing in a two-room apartment in New York City. Corning Glass Works bought me in 1982, only to spin me off in 1997 with a new name. Today, with a market value recently topping $15 billion, I'm the world's largest diagnostic information services company, serving about half the doctors and hospitals in America and over 30% of American adults annually. I employ some 47,000 people and rake in more than $7 billion annually. Who am I?
Last Week's Trivia Answer
I trace my roots back to Los Angeles in the 1930s, when Hubert Hansen and his sons launched a business in fresh fruit and vegetable juices. Later, I sold sodas. I filed for bankruptcy protection in 1988. I survived and expanded -- offering smoothies, vitamin drinks and energy drinks -- and got a (scary) new name. Some of my operations were later sold to Coca-Cola. Today, with a market value recently topping $42 billion, I'm an energy-beverage giant, with my drinks sporting words such as Burn, Full Throttle, Mother, HydroSport, Reign, Samurai, Relentless, Gladiator, Predator, Fury and more. Who am I? (Answer: Monster Beverage)
The Motley Fool Take
A River of Revenue
Long before COVID-19, millions already relied on Amazon.com (Nasdaq: AMZN) to deliver things they needed. As of January, the company reported 150 million Prime members -- who not only pay a subscription fee, but also shop on Amazon more than non-Prime members do.
The surge in orders resulting from COVID-19 boosted net revenue by 40% to $89 billion in the company's second quarter, demonstrating that Amazon can still grow briskly despite its massive size. Earnings doubled year over year to $5.2 billion. Fueling that earnings growth was the Amazon Web Services (AWS) business. Even though AWS accounted for just 12% of Amazon's revenue in its most recent quarter, it made up 58% of operating income. The good news for investors is that this unit is thriving, with revenue increasing 29% year over year.
In its most recent quarter, Amazon more than doubled grocery delivery capacity and tripled grocery pickup locations. Millions of people will be trying Amazon's services for the first time, and some will stick around and remain customers for the long term.
Costs remain high, but while the pandemic is causing surges in both revenue and expenses, the former is likely to last longer than the latter. When COVID-19 has run its course, Amazon will have attracted more customers, and will have fewer pandemic-related costs. (The Motley Fool owns shares of Amazon.com and has recommended its stock and options on it.)