There's no doubt that money can be made by owning shares of unprofitable businesses. Indeed, Megastar Development (CVE:MDV) stock is up 157% in the last year, providing strong gains for shareholders. Having said that, unprofitable companies are risky because they could potentially burn through all their cash and become distressed.

Given its strong share price performance, we think it's worthwhile for Megastar Development shareholders to consider whether its cash burn is concerning. 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'.

See our latest analysis for Megastar Development

How Long Is Megastar Development's Cash Runway?

A company's cash runway is calculated by dividing its cash hoard by its cash burn. When Megastar Development last reported its balance sheet in August 2019, it had zero debt and cash worth CA$408k. In the last year, its cash burn was CA$576k. That means it had a cash runway of around 9 months as of August 2019. That's quite a short cash runway, indicating the company must either reduce its annual cash burn or replenish its cash. Depicted below, you can see how its cash holdings have changed over time.

How Is Megastar Development's Cash Burn Changing Over Time?

Because Megastar Development isn't currently generating revenue, we consider it an early-stage business. Nonetheless, we can still examine its cash burn trajectory as part of our assessment of its cash burn situation. During the last twelve months, its cash burn actually ramped up 89%. While this spending increase is no doubt intended to drive growth, if the trend continues the company's cash runway will shrink very quickly. Megastar Development makes us a little nervous due to its lack of substantial operating revenue. So we'd generally prefer stocks from this list of stocks that have analysts forecasting growth.

Can Megastar Development Raise More Cash Easily?

Given its cash burn trajectory, Megastar Development shareholders should already be thinking about how easy it might be for it to raise further cash in the future. Generally speaking, a listed business can raise new cash through issuing shares or taking on debt. Many companies end up issuing new shares to fund future 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.

Megastar Development's cash burn of CA$576k is about 14% of its CA$4.0m market capitalisation. As a result, we'd venture that the company could raise more cash for growth without much trouble, albeit at the cost of some dilution.

How Risky Is Megastar Development's Cash Burn Situation?

On this analysis of Megastar Development's cash burn, we think its cash burn relative to its market cap was reassuring, while its increasing cash burn has us a bit worried. Looking at the factors mentioned in this short report, we do think that its cash burn is a bit risky, and it does make us slightly nervous about the stock. While it's important to consider hard data like the metrics discussed above, many investors would also be interested to note that Megastar Development insiders have been trading shares in the company. Click here to find out if they have been buying or selling.

Of course, you might find a fantastic investment by looking elsewhere. So take a peek at this free list of companies insiders are buying, and this list of stocks growth stocks (according to analyst forecasts)

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Simply Wall St has no position in the stocks mentioned. Thank you for reading.