Genetic testing company Invitation (NYSE: NVTA) has seen its stocks tumble from their highs despite the aggressive increase in its test volumes this year. The company is at the center of integrating genetics into healthcare, and this space still has so much potential.
However, sometimes a good story doesn’t make a good investment idea. Investors could buy the downside on Invitae, but they shouldn’t ignore a major blockage in its business model. Here is what you need to know.
The share price has become reasonable
Invitae generates income by administering genetic tests while regularly building a database of genome information over time. The more tests she administers, the larger and more in-depth her data, which she can potentially leverage to create new opportunities to help patients and generate new sources of revenue.
2021 saw a big step forward in the number of genetic tests it administers. Its billable volume in the third quarter of 2021 jumped 89% to 296,000 tests, pushing revenue up 66% year-on-year to $ 114 million.
If the company is performing well, why has the stock gone down? Growth stocks across the market were popular in early 2021, including Invitae, which had a price-to-sell ratio of 24, well above where it has traded in most of the past five years. . That valuation has since dropped significantly to just over 8, and stocks have fallen over 70%. It’s not just a drop, it’s a collapse. The result is action that is now much more reasonably priced.
The red flag with Invitae
However, Invitae has yet to make progress towards generating free cash flow despite having intensified its activities for more than five years in public markets. The more revenue Invitae generates, the more its free cash flow losses also increase.
Here is the problem. Invitae generated $ 114 million in third-quarter revenue, but spent almost as much ($ 93 million) on research and development and an additional $ 109 million on selling, general and administrative expenses. In other words, the company’s operating costs were 176% of revenue, which is worse than in the third quarter of 2020, when operating costs were 149% of revenue.
A young business often loses money when it invests for growth, but at some point the business has to exceed its expenses and start generating free cash flow. Otherwise, the economic model does not work.
Dilution could hurt investment returns
It is too early to say that Invitae’s business cannot function, but years of losses have caused the company to repeatedly raise funds by issuing new shares. This is common for growing companies, and the key for investors is that when a company begins to generate cash flow, it no longer needs to issue shares to finance its growth.
We can see below that the number of outstanding shares of Invitae has almost quadrupled over the past five years. When a company issues new shares, the existing shares are worth less. Think of it like a pizza cut into four slices, then cut two more times to make 16 slices. The pizza did not get fat; the slices have become smaller.
Investors should consider repeated increases in the equity of the company before purchasing the stock. Dilution hurts investor returns because it reduces the amount of earnings per share (EPS). The company could make more money, but if it continues to issue shares, the stock could remain stagnant if the new shares prevent EPS from growing.
Invitae has $ 1.2 billion in cash after spending $ 148 million in the last quarter, so the company shouldn’t need to raise more funds in the near future. However, investors who buy the decline on Invitae will need to monitor the rate at which the company is burning cash to determine if shareholders remain exposed to dilution risk.
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