Cash burn rate

Q:

Can you explain what a “burn rate” is? — H.D., Madison, Miss.

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

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.