Here's Why We're Not At All Concerned With Karuna Therapeutics' (NASDAQ:KRTX) Cash Burn Situation

We can readily understand why investors are attracted to unprofitable companies. By way of example, Karuna Therapeutics (NASDAQ:KRTX) has seen its share price rise 388% over the last year, delighting many shareholders. Nonetheless, only a fool would ignore the risk that a loss making company burns through its cash too quickly.

So notwithstanding the buoyant share price, we think it's well worth asking whether Karuna Therapeutics'cash burn is too risky In this report, we will consider the company's annual negative free cash flow, henceforth referring to it as the 'cash burn'. We'll start by comparing its cash burn with its cash reserves in order to calculate its cash runway.

View our latest analysis for Karuna Therapeutics

Does Karuna Therapeutics Have A Long Cash Runway?

You can calculate a company's cash runway by dividing the amount of cash it has by the rate at which it is spending that cash. When Karuna Therapeutics last reported its balance sheet in June 2020, it had zero debt and cash worth US$368m. Looking at the last year, the company burnt through US$40m. So it had a cash runway of about 9.3 years from June 2020. Even though this is but one measure of the company's cash burn, the thought of such a long cash runway warms our bellies in a comforting way. Depicted below, you can see how its cash holdings have changed over time.

How Is Karuna Therapeutics' Cash Burn Changing Over Time?

Karuna Therapeutics didn't record any revenue over the last year, indicating that it's an early stage company still developing its business. Nonetheless, we can still examine its cash burn trajectory as part of our assessment of its cash burn situation. Over the last year its cash burn actually increased by a very significant 59%. While this spending increase is no doubt intended to drive growth, if the trend continues the company's cash runway will shrink very quickly. While the past is always worth studying, it is the future that matters most of all. For that reason, it makes a lot of sense to take a look at our analyst forecasts for the company.

How Easily Can Karuna Therapeutics Raise Cash?

While Karuna Therapeutics 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. 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.

Karuna Therapeutics' cash burn of US$40m is about 1.9% of its US$2.1b market capitalisation. That means it could easily issue a few shares to fund more growth, and might well be in a position to borrow cheaply.

How Risky Is Karuna Therapeutics' Cash Burn Situation?

It may already be apparent to you that we're relatively comfortable with the way Karuna Therapeutics is burning through its cash. In particular, we think its cash runway stands out as evidence that the company is well on top of its spending. While its increasing cash burn wasn't great, the other factors mentioned in this article more than make up for weakness on that measure. After taking into account the various metrics mentioned in this report, we're pretty comfortable with how the company is spending its cash, as it seems on track to meet its needs over the medium term. On another note, Karuna Therapeutics has 4 warning signs (and 1 which is a bit concerning) we think you should know about.

If you would prefer to check out another company with better fundamentals, then do not miss this free list of interesting companies, that have HIGH return on equity and low debt or this list of stocks which are all forecast to grow.

This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.

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