by Tom Fahy
- Someone has probably said better what I am saying now. Keep that in mind.
- The way I value companies is not necessarily popular; I subtract almost all hope from the calculation.
- I take it for granted that anything can happen: a company’s entire management team could die in a plane crash tomorrow morning on the way back from delivering a keynote in Zurich. If all you have is the reputation of management and a PowerPoint presentation, but no rocks in the ground, that’s not gonna help the valuation as I compute it.
- I only calculate valuations based upon measured & indicated resources. If the company has probable and proven reserves, even better, but I’ll still have doubts about the feasibility of extraction and I’ll ensure that there’s a discount applied to account for ‘unknown unknowns.’ Because there are always ‘unknown unknowns’, cost overruns, exchange rate surprises, engineering hiccups, murders, natural disasters, coups, mechanical failures, unexpected seismic events from blasting, swelling interest on loans… You get the point.
Firstly, here’s the very simple approach I take to valuing exploration interests with actual resources and development-stage interests without cash flow from operations (most of them…). I keep it so simple a retarded caveman could do it:
Measured & Indicated Resources * Today's Price of Mineral * Discount Rate (10%) / Fully-Diluted Shares
Like I said, really simple math. I call it the ‘Stingy Acquirer Calculation’ or, aptly, ‘SAC’ — cause you gotta have a sack to get involved in this racket. If shares of the stock under scrutiny are trading at a discount to what I believe is true underlying value as I have calculated it (using SAC), it might be a company in which one might take a stake. Sometimes the difference between price and underlying value is small, so one would want to allocate enough resources to the stock to make that little trade worthwhile and be ready to liquidate when the gap has been bridged. In resource investing, that gap can close fast!
And that’s when investors begin to lose. The gap has closed and they extrapolate their short-term gains into a future wherein this particular, special miner trades at a larger and larger premium to underlying value. It can happen, but not often. Wins in mining shares are often fleeting. If you don’t take your profit when you get it, then you’ve got a new pet.
I know this because I commit capital to mining shares regularly. I both win and lose. The losses are relatively small as I am unwillingly to commit more than ~2% of capital to any single stock.
Investing in resource stocks requires preternatural patience. Most of the time, your holdings will go sideways until something lucky happens. Usually, nothing lucky happens. The vast majority of explorers drill nothing of note and developers go bust waiting for the price of gold, silver, platinum, uranium, etc., to rise, which hinges on luck, too. You never hear about these losers, but they all deserve our respect for trying.
Be mindful of it. It’s part of the game. But it is going to alter the value of those shares in which you are invested. Following a dilution, you’ve got to revise your target. The company is NOT the same company it was yesterday, prior to the dilution. It’s a little worse and so is your investment. Allocate accordingly to companies with diluted share-structures. If you make 25-100% on the trade on a stock with 1 Billion shares outstanding, take the profit and run like hell.
Don’t be a sucker. Don’t buy stocks because everyone is touting them. Stay away from newsletter writers. If you are paying for wisdom, you’re getting shafted. Period.
Investing in resource stocks is not rocket science, but holy cow, you have to dig like hell to find value and then wait for shares to fall into your waiting hands, which could take months or longer, then wait for the value gap to close, which also could take months or years.
So, if you don’t want to lose everything as a resource investor, you’ve got to be mindful of a few things:
- Get your capital allocations right — concentration may work for the guy that is pumping the stock, but that’s not for you (that dick is morally bankrupt). If you allocate 1.5-2% of your capital to each speculation, and if you have been mindful of ensuring you have a margin of safety, you’ll do fine… As long as you remember to sell when the selling is good!
- Be ethical in your dealings. And don’t do business with people that aren’t ethical in their dealings. We all know who these people are.
- Keep your valuation model simple and actionable. Ensure that it can be revised on-the-fly as the fluid prospects of your investments change.
- Finally, finding valuable minerals that may be extracted economically is harder now than ever before in modern history. Hence, finding investments that will prove out is harder than ever before in history. Consequently, in order to have a meaningful exposure to luck, you’ve got to own a piece of a lot of opportunities.