What is cash burn rate?
Can you explain what a “burn rate” is? — H.D., Madison, Mississippi
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.
A stock I own has been dropping. Should I buy more shares now that they’re priced lower? — P.L., Cerritos, California
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.
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. Both10-K and10-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.
Join in: If you have a question for the fool, visit www.fool.com.