HOW TO EVALUATE THE POTENTIAL OF A JUNIOR MINING STOCK
Editor: DARRELL BROOKSTEIN
COMPLIMENTS OF THE LONDON TAYLOR GROUP
*******************************************************
We have all heard stories about junior mining stocks which have soared in value 1,000% or more. As a point of fact, over the past couple of years, two stocks have posted gains which have dramatically highlighted the potential of resource stocks: Diamond Fields Resources soared 4,875% based on a massive nickel discovery in Labrador, and Bre-X rocketed 7,690% based on a major, high-grade gold discovery in Indonesia.
With their powerful potential, junior resource stocks have become a favorite speculation for thousands of investors. As with any high-potential investment, however, the junior mining sector can entail a significant degree of risk, especially for the uninformed.
The purpose of part one of this paper is to provide you with some basic guidelines that a professional resource inventor might follow in evaluating the potential of a "junior" mining stock. By doing some fairly basic homework, you can dramatically improve your odds of identifying stocks with solid upside potential, while systematically reducing downside risk.
MANAGEMENT COUNTS:
Experienced mining share analysts always start their evaluation of a mining company by looking at its management. In this business, management counts... and proven management counts more. Who are the key "players" in the company? What successful mining projects have they been involved with in the past? What was the share price history of the companies in which they have been involved (for example, did the share price soar on promotion, but then later collapse on reality?)?
Another useful tip-off to a company's potential is movement within its management and board of directors. When you see high-powered individuals leaving major mining companies to join the management team or board of a junior mining company, pay close attention. This can signal great things just ahead. Fortunately, such management additions are always announced in press releases by the companies you are following, so keep vigilant.
Likewise, if you attend an investment or mining conference (and if you are serious about investing in this sector, you should attend at least two a year), seek out representatives of mining companies that typically exhibit and inquire about their management and their past successes and future plans.
THE QUALITY OF A CONCESSION,
PROPERTY OR DEPOSIT:
Robert Bishop, one of the most closely followed mining analysts in North America, recently said that where 90% of the mining projects that came across his desk several years ago were garbage, and only 10% were of high quality . . . today those percentages have reversed, with 90% being high-quality and only 10% falling into the "junk" category.
This trend is a positive development for investors because it helps lower the risk that has been traditionally identified with junior mining companies. By concentrating only on those companies that have sizable, high quality deposits and an undervalued share price, one can greatly refine the selection process so that one invests only in the best of the best. We'll talk about how to tell if a company's share price is undervalued in a moment, but first let's touch on the issue of "quality" itself.
The days of independent prospectors with picks and mules wandering through the wilderness looking for the Mother Lode are long gone. Even if they were fortunate enough to stumble across something of value, there is no way that they would have had the financial acumen, legal or negotiating experience needed to lay claim to the land, fight their way through the layers of red tape or raise the millions of dollars required to put a mine into production these days.
A top junior exploration company will inevitably have the management expertise needed to not only identify an attractive concession, but also to secure the rights to it on favorable terms. An increasing number of mining opportunities are being found in distant countries with lower regulatory and tax burdens. Therefore, management must have the savvy needed to negotiate highly complex deals that often include partnering with foreign corporations . . . and with major mining companies who can provide the much needed financing and operating expertise for developing a concession or property into a mine.
However, all of these considerations are for naught if the company doesn't first secure the rights to a significant and economically viable property. In mining, all things being equal, the bigger and richer the target deposit, the better. Simply put, economies of scale are a major factor in the profitability of a mine (i.e. once you've paid for the basic cost of building a mining facility, the more final product you process, the lower your overall cost per unit of product).
Additionally, the major mining companies do not waste their time or money on small deposits - even "rich" ones. Thus, a big deposit is far more likely to lead to either a joint venture with a major, or, as is often the case, in the sale of the entire company to a major. Either event can mean big profits for early investors.
ACCESS TO FINANCING:
Once a major resource has been identified and secured, the mining company must take steps to develop it and move it towards production. Typically, these are very expensive steps, usually calling for aggressive sampling, trenching and drilling/ evaluation programs which are undertaken in order to better "define" the size and grade of the resource and determine the economic viability of its exploitation. (One fine point, which is often lost on novice investors, is that huge quantities of minerals, in thousands of deposits worldwide, have been developed as "proven resources" at extensive expense and drilling that are not "ore". The junior resource share investor must ascertain if any resource is capable of being recovered economically; in a sense, this defines "ore".)
This work is followed by the commissioning of a "bankable feasibility study" - studies by recognized independent sources which can cost millions of dollars, that clearly outline the economic feasibility of mining the deposit. Clearly, engineering, metallurgical and environmental issues are of significant concern at this stage and can supersede or negate all the "geology" in the world. If everything checks out, really big money is usually needed to actually build a mining facility and to purchase the usual assortment of trucks, bulldozers, etc.. As you can imagine, each step towards production requires a lot of money because as the saying goes (even with the tremendous leaps in technology over the past decade) "you can't see underground". It sometimes happens that an 8 million ounce gold deposit that looked so good on paper is 800 feet below rock with a "work index" which is too high to support the construction of the mine and mill and return a profit at current metals prices and projected operating expenses.
While few companies ever make discoveries of interesting deposits, even fewer that make interesting discoveries actually have "ore" and develop mines.
There are several ways that a junior
mining company can raise the money
they need.
They can issue additional shares, which can be either a positive or negative. On the one hand, issuing some shares can help the company to raise the money needed to take an important step in their growth that will later reward investors. It's negative, however, when too many shares are issued for an uncertain gain or an overvalued asset, as this can dilute the early shareholders.
Another way to raise financing is to joint venture with a "major". Smart management can often negotiate a deal so that the major pays virtually all costs associated with drilling and for producing a bankable feasibility study. Then, if the decision is made to go into production, the major can be committed to provide project financing for the junior to fund their share. Of course, the only reason that a major would agree to this is if they receive the lion's share of the junior's property and operating control. If the project is strong enough, this is all to the junior resource company's benefit. They are typically left with a carried interest in the property. As a shareholder, you'll go along for the ride . . . and it can be quite a nice ride!
Another popular way to finance a mine is through the issuance of debt. This is often done in conjunction with issuing additional equity. In these cases, if a company's prospects are sufficiently favorable, an investment banker or even a major mining concern may agree to provide up to 70% or more of the financing necessary in the form of a debt instrument that is paid back by cash flow from the mine. This can be a good arrangement, as it reduces the dilution of shareholders.
ASSETS vs SHARE PRICED:
In recent years we have seen the phenomenon of companies with market capitalizations (the number of shares outstanding multiplied by the price per share) in the hundreds of millions of dollars . . . that have yet to complete a basic exploration drilling program! To greatly increase your odds for success, you'll want to concentrate on undervalued companies . . . companies with a share price that is at a discount to the net present value of the company's underlying assets.
Here's one simple formula you can use to determine value:
Multiply the number of shares issued by the current share price. This will give you market capitalization.
Compute the total dollar value of the company's assets. Generally what you are looking for is cash in the bank, plus cash spent developing the property, plus the total value of the company's proven and probable reserves discounted by 80%. Comparing (b) to (a) will provide useful information. If a company's "assets" are $10 million, but it has a $50 million, much less $150 million market capitalization, it is almost certainly treading in dangerously overvalued waters.
Divide the result of (b) by the number of shares outstanding. This will tell you what the value of the share price should be if the company was fully valued. If the current share price is far below the true asset value per share of the company, your odds of making a bad investment are significantly reduced. If it is significantly higher, you are paying for "blue sky" or must be very confident that the deposit will grow or the company will make new discoveries. This short "rule of thumb" attempts to approximate two important numbers:
The private (as opposed to public) market value of a prospect or group of prospects.
The discounted pre-tax cash flow that can be potentially derived from a project, mine or group of projects over a period of years.
While very inexact, the above value formula is a quick way to help you stay out of trouble. Just understand, pros go to much greater lengths to value companies, but 99% of all retail customers fail to run even this simple screen
STAY INFORMED:
The above "lessons", while important and useful, are fairly basic. There are a number of other factors that can make all the difference between success and failure in mining shares. To name a few, the accessibility of an ore deposit and the technology required to exploit it . . . the attitude of the local government . . . the level of promotion undertaken for the stock . . . and much more.
Metallurgy, governmental and environmental permits, political risk insurance, stripping ratios (waste rock to ore), depth and attitude of deposit, water and infrastructure availability and the potential for further expansion of the ore are all issues.
"Promotion" is probably the most misunderstood of all the elements in the development of a junior resource company.
Misused, promotion is puffery at best and deception at worst. While pure scams are rare, even in this field, millions have been lost to unscrupulous promoters who take advantage of the ignorance of the investing public about mining and the simple caveats in this report.
Properly used, promotion is financial community public relations and corporate development. Every public company needs an active, professional promotion campaign. Drill holes do not speak. Telling the company story in its best light to as many appropriate people and institutions as possible is an obligation the officers and directors owe their shareholders to ensure a liquid market for their shares, a fully valued fair share price and the ability to finance without undue dilution to the current shareholders. The company should have the way prepared with ease and access to the larger financial community.
As with any investment, the best way to consistently come out on top - and in junior mining shares, that can translate into mega-profits - is to study the topic and to stay closely in touch. There are a number of regular publications and resource-related conferences available that have proven their worth over the years. Information on these services follows. You would be well advised to avail yourself of as many of these resources as your time and budget allow. As the old saying goes, "Knowledge is power." In the natural resource sector, you could rephrase that as "Knowledge is profit!"
HOW THE PROS BEAT THE MARKET:
You have just learned some basic techniques for avoiding scams, pure promotions and financial loss in the junior mining sector by sticking with VALUE. But how do you buy a Diamond Fields at $2 on its way to $25? After all, it was deeply undervalued at $1 5/share. Diamets, Bre-Xs, Diamond Fields and even Arequipas come along rarely and even the top junior mining analysts miss these once in a lifetime opportunities. However, many pros regularly capture 100% to 1000% moves (along with the inevitable losers) by being a step ahead.
How do they do it,
Their key is not simply that they recognize value early. They competently PROJECT VALUE.
Simply put, they project "value" BEFORE it is "drill proven" by carefully and knowledgeably analyzing data before the drill turns. Sophisticated mining professionals can read surface sampling, trenching, induced polarization, chip samples, and geo-chem and magnetic anomaly information like a book. They know that certain indicator minerals in certain geological settings can increase the odds of discovery.
They can compare the results of one prospect to another within the same trend or discovery area and rank their prospective value accurately.
They know management teams personally and they know who is conservative and who is not. They know when dilutive private placements of stock are being made and they may participate in placements they deem likely to be profitable. They have professional friends on-site or they go on-site themselves.
They understand the value of market support and proper promotional activities and the mine discovery cycle. They ask for and know the financial PR budgets of the companies they invest in and they know that any firm spending less than $200,000/ year in this important area is fighting an uphill battle. They read between the lines of company press releases. They know when a "new" big drill hole is meaningless and when an apparently "weak" hole is supportive. They analyze current major share holders for buying and selling motivation and time their purchases and sales to their advantage based on this information. They assiduously digest analysts' reports and even instigate them. They watch news of insider transactions.
They are true insiders and they reap tremendous benefits.
As a non-professional, you have only two ways to actually accomplish what they do. You can become a full-time pro yourself or you can entrust some portion of your funds to a trustworthy professional.
The alternative is to be the best non- professional you can be by using some or all of the techniques and information provided here and in other good sources. You'll definitely want to receive part two of this report.
A surprisingly large number of investors, no more astute than you, have built fortunes for themselves in recent years by investing in junior mining shares. All it takes is a little research, a little patience and lots of good information: Information of the sort regularly provided to investors and financial and mining professionals who stay in contact with the London Taylor Group.
We hope you have found this brief paper of value and that you will be able to look back in years to come on the sort of mega-profits that can come from intelligently investing in junior mining shares. On behalf of the entire team at the London Taylor Group, we would like to wish you "good hunting!" |
