Recently, I was approached by a company that was looking to drum up investors. Without giving away who the company is or what they do, I’ll briefly describe them in this way: They’re a non-publicly-traded B2B business with a 2-decade track record of success in an industry that is growing in demand. And they were looking for investors to help fund some upcoming initiatives. Cool. I like hearing about those kind of opportunities.
They got in touch to see if I was interested in investing with them. Their call was sort of a cold call (because I’d never heard from them before and this was the first time they were reaching out to me), although it technically wasn’t a cold call because we were connected through a social network and I had indicated that I was interested in hearing about investment opportunities.
On the call, they briefly introduced themselves and talked about the opportunity. The offer itself wasn’t clearly described on the phone. Was it an equity investment? Was it a bond? From what I could tell, I was supposed to give money to the company and they would use it to help their clients and then I would get my investment plus a return back. When I inquired further about what kind of offer it was, the caller wasn’t clear. Then she apologized because she is normally the one in the field but was making calls to investors that day.
Hmmm… a couple of red flags there but nothing that will turn me off yet. I can research my answers. So I asked if I could review any additional information to do my due diligence and they pointed me to their website.
And here’s where it fell apart:
Their website is very plain (which is fine) but it screams “old school”… in other words, it feels like a website from about 5 – 8 years ago. And the deeper I got into their site, the older it seemed. (One page looked like it was made in 1995).
Their website mixes content for clients and for investors. This is frustrating for both audiences — they need to divide up their content and make it obvious on the first page who should be sent where. (This is simply done with a button that says: “Clients click here” and “Investors click here”. It keeps the messages from getting mixed up and it helps with tracking what each audience does.
Their presentation page listed the available presentation but the password I was supposed to enter had the number “2009″ into it. Does that mean the presentation is from 2009? I hope not because no investor should do due diligence based on information that is 4 years old.
Once I entered the password and clicked “view presentation”, a pop-up displayed that told me “this presentation is only viewable in Internet Explorer or Netscape Navigator”. Really? Hey, we live in a world where there are numerous browsers (many of which are more popular than the two listed above) and even if something doesn’t display 100% correctly in my browser, I’m fine with it. But to block investors out completely because they’re using Firefox or Safari or Chrome is a little crazy.
But I’m a determined person so I dug around on my computer until I found Internet Explorer and I dusted it off and opened it up, and went through the process to find their presentation and enter the password… only to be told that I had to download some program first.
That ended it for me. I have many investment opportunities available to me that promise equal or better returns than what this company was offering and it takes a lot less work to do my due diligence.
If you are a business looking for investors, here are some lessons for you from this experience:
Make sure your offer is clear. This company did okay talking about what they do and what my return was but they fell apart when talking about what structure the investment actually was.
Have dedicated fundraisers/investor relations people. When someone apologizes because they don’t normally make investor calls and are usually in the field, that’s sort of a red flag for me. I don’t mind that field people take the time to meet investors but in some cases (like when field people make cold calls) it smacks of desperation. At the very least, your investor relations people will at least have the skillset needed to raise funds.
Appear current: You don’t have to have the most cutting edge website but it should look like someone has touched it in the past 2-3 years.
Use a variety of distribution methods to get your information out there: There are many “platform-agnostic” ways of distributing information: On-page text, embedded video, PDF… just to name a few.
Investors want to invest money. That’s why they define themselves as investors. If you are a business who wants money from investors, you need to make it easy for investors to invest. Think of investors like customers — the easier you make it for a customer to buy, the more likely someone will buy from you.
Stock prices go up and they go down. Since 2008, stock prices have fluctuated (sometimes wildly) and investors don’t always know what to do.
The expert advice out there is mixed: Some wisdom says “Cut your losers and let your winners soar”, meaning that you should only hold stocks that are generally going up. Other wisdom says that the best time to invest is when other people are running scared from a stock, meaning that you want stocks that other people see as losers (i.e. the stocks that are down).
So what should you do if the prices of the stocks in your portfolio drop? Cut them? Hold them? Buy more?
Here’s what I think…
Assuming that you did sufficient due diligence when you first bought the stock, then identifying the changes in the market’s valuation of the stock as well as the overall market sentiment can reveal what you should do.
Dig into the news about the stock. Ask yourself this question: “Why has the market changed its mind about the value of this stock?” Figure out what has changed: What news item or piece of information has altered the trajectory of the price?
Take a step back and look at the wider picture — the industry and the market as a whole. What’s happening at the bigger level that might have an influence on this stock?
Then use a chart like this as a guide to know what to do with the information you’ve discovered above…
If information about the company of the underlying stock has remained the same and if the market is unchanged (upper left quadrant), then this price drop could be something else, such a temporary sell-off (i.e. for tax loss purposes or institutional investor portfolio rebalancing). In those cases, I prefer to double-down and buy more.
If the information about the company of the underlying stock has changed but the market remains unchanged (upper right quadrant), then I need to take a closer look at the stock — to revisit whether I think the fundamentals are still true and to sell if they are no longer true.
If the company hasn’t changed but the market has (lower left quadrant), then I’ll revisit the stock but in general have tended to hold my stocks during this time. Market corrections are cyclical and I’m not going to worry about them too much.
If the company has changed and the market has changed (lower right quadrant), then it is very likely time to sell because my entire profit thesis when I first bought the stock is no longer relevant.
This chart isn’t ever going to be perfect for everyone — we each have different investing goals and time horizons — but when you open up your portfolio and see that one or more of your stocks have fallen, a tool like this is a useful way to take a step back and apply a layer of analysis to the situation so that you don’t simply sell in an uneducated knee-jerk reaction.
In an episode of West Wing (still one of my favorite shows!), two characters are talking about PBS television and one of them says that more people claim to watch PBS than actually do watch PBS. The reason is: People like to think of themselves as being PBS watchers even if they aren’t.
Likewise, many philosophers and gurus have shared the following wisdom (which I’m collectively paraphrasing): You can tell a lot about a person, not by what they say but by what they actually do.
With this in mind, I want to talk about the irony of the conservative investor.
Many people who claim to be conservative investors are not really conservative investors. They’re just ignorant aggressive investors.
My parents would describe themselves as conservative investors, as would several of my friends. But when we talk about their actual investment practices, the situation is VERY different. And they are not alone. I saw this when I was a stockbroker, and I still see it today: If you were to ask people if they were conservative investors, you would get a lot people saying they are because they think of themselves as being careful and risk averse.
But they only THINK they are conservative investors… they really aren’t. They believe they have carefully invested their money into quality stocks that are widely diversified, and that their investments are truly safe (in spite of the fluctuations of the market).
But my experience with investors tells me something completely different.
Investors put some of their money into mutual funds based on advice from others or on past performance (in spite of the disclaimers). And, they put some of their money into equities but they chose those equities based on over-the-fence hearsay from their neighbors and friends… or because they spotted the name of the stock on the 6 o’clock news or on a magazine cover.
Ask any advisor and they will be able to tell you a story that is similar to this one: They’ve been advising a client to go into a blue chip stock for a while but the client is reluctant because they feel the stock market is too risky. But then those same “conservative” clients call up the broker because their neighbor knows someone who is suggesting they jump into a penny stock… No due diligence; no second-guessing; no analysis against portfolio goals.
I even had one brand new client show up at my office once and, even though she described herself as a conservative investor, randomly point to a screen of stocks and ask to put her entire available capital into ‘that’ one… just because everyone else was investing in stuff and she wasn’t.
Many conservative investors are not conservative at all. Part of the problem is simply not knowing how to invest — they think they can diversify themselves out of all market risk. But part of the problem is that they aren’t the conservative investor they think they are — they don’t want to do due diligence and they jump on whatever hot stock there is right now.
What’s the solution? I’m not sure. Most good stockbrokers and investment professionals will talk their clients down from the ledge of aggressive investing but wouldn’t it be great if investors were shown HOW to be conservative investors before they picked up the phone to call their broker? I think education is the only answer.
I was recently talking to one investor who was frustrated by the market and wanted to put all her money under her mattress… and just didn’t “get” what I was saying when I tried to explain about the costs of inflation. And another investor asks me for stock ideas but he only wants ideas of stocks that go up… as if I would know that ahead of time. (Disclaimer: I don’t give stock ideas at all, but people ask me for them all the time, which should be a sign of a non-conservative investor!)
Perhaps what needs to happen is that advisors and financial professionals need to draw more of a connection between the claim of what it means to be a conservative investor and the actual practice of being a conservative investor. When someone states on their investor application form, for example, that they are conservative, it should put them into an educational program where they are equipped to be conservative. They should be able to know the qualities or characteristics of a conservative investor and be equipped to make decisions through the lens of a conservative investor. And there should be a more difficult process to switch from conservative investing to aggressive investing.
Perhaps stockbrokers need to share the due diligence process with their clients (instead of just having a conservative client show up and say: “Put some of my money into Bre-X”.
A seminar series about conservative investing might help people to understand what it means to be conservative.
Ideally, a conservative investor who gets a great stock idea (from their completely unqualified-to-give-advice friend) should have an easy step-by-step method to do their own initial due diligence before they call up their broker and ask to put some of their money into the stock.
There are many people out there who claim to be conservative investors but their investing practice suggests something entirely different. I think it needs to be fixed.
How can investors value a junior resource company so that they know whether or not they should invest in it?
While mowing the lawn, you see your neighbor so you walk over to him, lean on the fence, and chat for a while. He asks you, “So have you heard about ABC Gold Exploration Inc? They trade on the TSX and I hear they have just discovered the world’s greatest deposit of gold… EVER.”
What do you do?
Some investors (too many, in fact) will run to their online self-directed brokerage account, check the symbol, and then stick some money into the stock. After all, their neighbor seemed pretty sure of himself.
Sure, we might SAY that we never do this… but it happens. MANY investors do exactly this.
In my experience, people love the idea of risky stocks but they hate risk, and they want to be cautious investors but rarely examine stocks closely before buying them (and instead are guided by emotion and the momentum of a stock’s popularity or unpopularity). Yes, that last sentence seems full of contradiction but it seems to be how people tend to trade.
So let’s say you hear about a junior resource stock. What should you do?
Regardless of the source (whether it’s an completely uninformed source, like your neighbor, or the most trusted source like an industry expert), you need to do the following 3 types of due diligence investigation BEFORE you a penny into that stock.
STEP 1: AM I READY TO INVEST?
Before you ever invest in anything, you need to do some due diligence and the first part of your due diligence is to take a close look at yourself. What kind of investor are you? How much risk can you handle? How much volatility can you handle? Will you lose sleep if your stock goes up by 25% one day but drops by 50% the next day? What happens if your stock drops by 75% and then stays that way for a long time? How much do you want to gain and how much are you willing to lose? What is the timeline that you want to make your money back?
So, before you jump into a stock just because your neighbor’s friend’s cousin knows a guy who heard something good about the stock, here’s what you need to do:
General due diligence action: Start by performing a personal assessment about your financial portfolio. The first 28 questions on my How to do your own due diligence blog post will help you with this.
It’s a good idea to revisit these questions periodically (schedule time to think about them once a month or once a quarter. It will go quickly because most of the answers will stay the same but it’s worth figuring out if anything has changed and how that impacts your investing).
If your due diligence reveals that you are okay with the risks and rewards that junior mining companies present, then you can move on to the next step…
STEP 2: WHAT IS THE MARKET LIKE?
Next, you look at the two elements that drive the stock market in general (and the prices of the specific commodity you’re looking at). Those two factors are: The supply/demand ratio and emotion. Examining the supply/demand ratio helps you understand the underlying fundamentals of the company while examining the emotion in the market helps you understand how excitement or fear can impact the price of a company.
You will gain a large advantage over other traders when you examine these two factors at the stock market level and at the more specific resource market level (because they are not always the same but they can influence each other).
The supply and demand ratio: Current metal prices (“commodity prices”) have an impact on the progress of a junior resource company, and metal prices are determined by supply and demand. If a company is operating in a market that has no demand or too much supply, commodity prices are low and it doesn’t make sense to explore, build, and operate a mine. However, if demand is high or supply is low, commodity prices might make it worthwhile to explore, build, and operate a mine. So it’s critical to understand supply and demand, and commodity prices.
Slightly more difficult to identify are the underlying factors that drive supply and demand. Understanding what those factors are doing, and will do in the future, can help you know what the supply and demand is going to be like. For example, copper and molybdenum are driven by industrial growth and infrastructure growth. Graphite is driven by growth in the automotive industry, tech industry, and in the growth of Lithium-ion batteries. (Learn more about the underlying factors driving graphite’s supply and demand at GraphiteInvesting.com). Gold is driven by a sense of unease in the market (so people buy gold as a hedge). And so on.
Junior resource due diligence question: What are the underlying factors that drive the commodity price?
Junior resource due diligence questions: What has the commodity price done in the past? (See IndexMundi for the answer) And, does it confirm what I’ve just discovered about the underlying factors that drive the commodity price?
Junior resource due diligence question: What are those underlying factors doing right now? (Further research might be necessary to determine the answer to this question).
Junior resource due diligence question: What do I think those underlying factors will do in the future? (Further research might be necessary to determine the answer to this question).
Emotion: Although individual stock prices might reflect a lot of the information available to investors, the stock market is largely driven by sentiment. Happy investors who feel like there is plenty of money to be made will invest. Scared investors who are afraid of losing their shirt will keep their money out of the stock market. This supply of money in the market (high during good times and low during bad times) drives prices up and down. And contrarian investors who understand the concept of buying when prices are low and selling when prices are high can benefit. This excellent article explains the cycle of market emotions.
Junior resource due diligence question: Using the cycle of market emotions, where is the overall stock market currently?
Junior resource due diligence question: Using the cycle of market emotions, where is the underlying metal of the junior resource you are examining?
Junior resource due diligence question: Using the cycle of market emotions, where is the junior resource company you are examining?
So, we’ve looked at supply/demand and emotion in the market. Here’s how I like to use the information when I invest: In general, I like it when there is a lot of ongoing demand but little supply, and I like it when there is a lot of fear in the market. The reason is: The fear drives the price of the stocks down, which makes it perfect to buy low, but then the ongoing demand brings prices up. Then, as the emotion in the markets becomes less fearful, the prices go even higher.
Just because I invest like that doesn’t mean you have to invest like that. There are other equations of supply/demand and emotion that might influence your trading. But it’s what I like to do (and it’s why I’m investing in specific parts of the junior resource industry right now when I can find good demand, low supply, and a lot of fear.
This step gives you the “context” or the “climate” in which you are investing, and it helps you understand some of the factors that will affect your price that are larger than the company you are investing in. Now it’s time for the last step…
STEP 3: WHAT IS THIS JUNIOR RESOURCE COMPANY LIKE?
Now that you’ve spent time figuring out how comfortable you are with risk, and what the larger investing context is like, now you are finally ready to take a closer look at the junior resource company itself.
Some investors want one single number to determine the value of the company but there are many factors that will influence that number and that might work for Warren Buffett but he doesn’t deal in junior resource stocks. It is possible to find undervalued stocks but you can’t always easily compare one company to the next because there are political and commodity considerations to take into account.
For us junior resource investors, it’s not easy to compare one company with another. A gold company in Bolivia needs to be valued very differently than uranium company in Saskatchewan Canada. Instead, investors need to examine the following factors to determine whether they feel those factors are acceptable to them.
Business model of a junior resource company: A business model is the way a business is structured to use its competitive advantages to operate and make money. Different companies will bring different strengths (and weaknesses) to a business model. You can start answering these questions now but you might refine them as you continue through this part of the junior resource due diligence.
Junior resource companies have business models like “Prospector” (where a company searches for resources), “Explorer” (where a company acquires a claim from a prospector and explorers it further, perhaps bringing the mine through the feasibility stage), “Developer” (where a company takes an explored resource and builds a mine), and “Producer” (where a company mines the resource and brings the product to market). Many junior resource companies do more than one of these roles (some are prospectors and explorers, some will prospect, explore, and develop, others will take a mine from discovery all the way to production). There are also hybrids of this model. A “Project Generator” business model is a good example – where a company will explore a resource and then partner with a senior company to develop the mine and extract the resource. And some mines don’t just take stuff out of the ground, they have a “mine-to-market” business model where they hope to extra minerals and then mill them into sellable metal.
I haven’t found a lot of information written on junior resource business models (and different companies might use different language to describe what they do) but each model has its own opportunities and challenges. For example, an explorer might not have a lot of cash flow so it might have to go back to the market frequently for money (until it sells its deposit or partners with a larger company). And a developer/producer might make some good cash flow but it is expensive to build a mine, so they need a lot of money up-front. Knowing what the model is gives you a point to start thinking about the opportunities and challenges that the company faces.
Junior resource due diligence question: What is the business model of that junior resource company?
Junior resource due diligence question: what strengths and weaknesses does this business model represent (and how will these strengths and weaknesses impact the company and the price of its stock)?
Life cycle of a mine: All mines go through a pre-defined lifecycle – from the point where a prospector takes a closer look at a big piece of empty ground, all the way through to the point where a giant mine is in operation. (This is related to the business model, above – often, companies derive their business model by specializing at a point in the life cycle of a mine).
There are several stages in between the prospecting and the finishing mine, and each stage has its own risks and rewards and opportunities and challenges. (Note: Some companies have several mines in one stage of the life cycle while other companies might have several mines that are each in different stages.) To familiarize yourself with these risks and rewards, a good place to start by taking a look this video below…
Junior resource due diligence actions: Using the above information, figure out what the company is doing now and will need to do in the future to move forward in the process. Then determine the impact on the company and the impact on the stock price. You’ll also need to think about the level of risk at each stage – what the risks are and how the company is handling those risks.
Resource: Now it’s time to do some due diligence around the actual resource of the mine. You’ll want to pay attention to the following three factors (assuming that you have already done the other due diligence listed above):
The amount of the resource (how much is there?)
The extraction plan (how easy or hard it is to get the resource out of the ground?)
The purity of the resource (how much work is required to make the resource ready to turn it into a product?)
Each type of metal measures the resource differently – some by tons, some by ounces; some use open pit mining; some have very pure minerals that require little separation from the impurities while others need to be separated out of the ore. So don’t be dazzled by the individual numbers without getting some comparisons.
A really helpful resource that is written about gold (but is useful even if you invest in more than gold explorers) is this PDF entitled Models and Exploration Methods for Major Gold Deposit Types. It gets pretty detailed and scholarly (you WILL scan some of it instead of reading it because it’s not very exciting) but it’s about as close as you’re going to get to digging in dirt without getting dirty.
Junior resource due diligence question: What is the geology of the area of the world where the junior company is working?
Junior resource due diligence question: How much resource is claimed to be there?
Junior resource due diligence questions: How does this amount of resource compare to other companies in the same area? (How much resource do those other companies have? Are they finding more? What is the purity? How hard is it to get out of the ground?)
Junior resource due diligence questions: What is the company’s plan for making money from that deposit? How far away are they from achieving their goal?
Politics and Location: Junior companies operate in different jurisdictions – both politically and geographically. Each one will have an impact on how successfully a mine operates.
Political jurisdictions might be mining friendly, mining unfriendly, or unstable (politically unstable examples include: A country might unexpectedly nationalize a mine that has just been discovered, or a government might collapse during a coup). So investors need to determine what the political landscape is of the area that the junior resource company is operating in.
Junior resource due diligence question: Is the political landscape stable or unstable?
Junior resource due diligence question: Is the political landscape pro-mining or anti-mining? (Along with political leaders, consider different interest groups that might have a strong say in whether or not mining work is completed in a particular area).
Part of the location question is the question of infrastructure. If there is water, power, roads, and a potential workforce nearby then it is much easier and cheaper to set up a mine, compared to those situations where a mineral deposit is discovered far from civilization and diesel generators have to be barged in only when the water isn’t frozen.
Junior resource due diligence question: What is the infrastructure like? (No infrastructure can mean higher costs to develop a mine).
Management: Next, investors need to look at management. Since just about anyone can start a junior resource company (no experience necessary!), it’s important to know what the background of the management is and whether they are experienced and skilled at operating the company with the business model, life cycle, and location that they are working in.
Look at the website to get a list of management and the directors. Then look at the following:
Junior resource due diligence questions: What is the experience that each person had? Although longevity in the industry is one helpful indicator, it’s certainly not the only one. Also ask: How much experience has this person had with this particular type of business model?
Junior resource due diligence question: What connections do management and the board of directors have with larger companies? Is there a potential joint venture relationship possible?
Financials: The financials of a company will also help you to value the company and they are essential for you to review. I’ll go into detail in a moment, but here is a bird’s-eye-view of the numbers you want to pay attention to:
Are there ways that the company is making money right now? Do these support exploration?
How much cash does the company have right now?
How much is the company spending right now?
If the company doesn’t get any more money, how long will it last until it needs to find more?
How will the company get more money if it needs the money?
Below, I’ve provided a number of really helpful resources. Each one gives you a slightly different perspective or way to value a company. I don’t think there is any one single right way. I prefer to do several of these methods and decide how I feel about the company based on a collection of numbers.
So, to get started, go to the company’s website or to a site like Yahoo Finance to get their latest financials. Then go through the list of videos, websites, and PDFs I’ve provided below to piece together a picture of the financial health of the company.
InformedTrades.com provides the following 3 excellent videos about how to understand financial statements of mining companies. Watch these! They are very good.
Roger Montgomery shows us how long the mine will survive at the current amount of money it spends:
The really good stuff is between 1:20 and 1:45
His advice is to look at a company’s expenses over the year, divide the number by 12 to determine the cash burn rate. Then look at the how much money the company has in the bank.
This article from Gold-Eagle.com called Mining Company Fundamentals 101 provides excellent detail on share structure, ownership percentages, and value calculations. They do discuss other points in this article but the first half of the article is devoted to financials and is quite informative.
Each company will need to be weighed on its own financial strengths and weaknesses. You are looking for the answer to this question:
Junior resource due diligence question: When will this company become profitable and will it need to dilute its share price or borrow more money to get to that point?
Answer that question and you will have a fairly good idea of what to expect. Ideally, you want a company that has cash flow coming in from operations (perhaps selling or JVing properties or selling ore). If you don’t have that, then you want a company that has money in the bank that can afford to explore or extract the deposit for a while before it needs more money.
ADDITIONAL MUST-USE RESOURCES
8 Page Guide: Resource World Magazine put out a great 8-page guide to valuing a mining stock. This guide gives a good introduction to various aspects of a junior company – including geology, mine life, and financial calculations.
Excellent video from BuchanBullBullion: This guy does an amazing job of outlining great tips, ideas, and websites that investors should look at when they are doing junior resource due diligence:
Some highlights from the above video:
1:35 – 2:03: How to research management
3:10 – 3:54: How a little knowledge can help you profit from volatility
3:57 – 7:05: Fundamentals to look for in a junior company
7:05 – 14:00: Understanding the lifecycle of a mine
ResourceInvestor.com: This article from ResourceInvestor.com called How to value a mining share goes into greater detail and lists 8 factors that investors need to be aware of when they are valuing a mining company.
WHAT YOU END UP WITH
After doing all of this research, what do you end up with? Unlike some stock research, you don’t end up with a single, simple number that indicates whether or not you should buy the stock. Instead, you end up with a sense of the company’s short-term and long-term health, and short-term and long-term opportunities. You end up with enough information to either feel comfortable about owning the stock because you reasonably expect the price to go up, or uncomfortable about owning the stock because you reasonably expect the price to go down.
Of course there will always be things you didn’t consider — a CEO who goes rogue, a crazy investor who gets the jitters and sells their holdings and drives the price down, etc. But in general, you gather enough information to feel overall bullish or overall bearish… for good reason.
If and when you decide to invest, the next step is to “screw your courage to the sticking place”, as they say in Shakespeare, and be confident in your purchase. If a stock price falls but nothing has changed in the information you gathered then there is no need to sell. To help with this, I suggest you develop an exit strategy for each stock.
An exit strategy consists of the following elements:
A profit thesis (the reason why you own the stock and expect it to go higher
A best-case-scenario exit strategy (the point at which you will exit the stock or at least re-evaluate whether you should continue to hold the stock). I like to include a share price and a date.
A worst-case-scenario exit strategy (the point at which you want to jump off of the sinking ship).
Here are a couple of examples of my profit thesis: I hold one company because it has an amazing gold resource that is increasing in size, is run by management with plenty of experience, and is in a politically stable area. My profit thesis is that as long as gold is in demand, and as long as this company can find more and then extract it, they are going to do okay. But I’ve also set a price and a date in the future. If either of those become true (the price rises to the price I’ve identified, or the date arrives that I’ve identified) then I will re-evaluate.
Another example: I hold a company that owns a past-producing mine and on-site mill. They have all of the infrastructure and they have a new deposit. My profit thesis is that I believe the stock price is going up as soon as they can get their new deposit out of the ground and into their on-site mill. Again, I have a price and a date and I’m just waiting for either of those to be true before I do anything. The stock has gone down — (it dropped by 30% this spring!) — and there were many days when I had to go back to my profit thesis to remind myself why I bought the stock. Nothing had changed except for market emotion so I stayed the course.
As you can see, there are many things to consider when doing your due diligence in in a junior resource company. Look at as many facts as you can and decide whether you believe the stock’s potential risks and potential rewards are right for you. If they are, buy with confidence and courageously hold your stock until the facts change.
Junior resource companies are like the many-headed Hydra: One dies and two more will take its place. Every time I turn around, another junior resource company is proclaiming that it has struck a bonanza-grade deposit of whatever resource it’s exploring for, the deposit goes ALLLL the way down, and they’re neighboring the greatest producing mine of all time.
As an investor, it’s easy to get caught up in the hype and to spread yourself too thin as you look for compelling investments – in one day you might look at a gold explorer in the Abitibi belt and then a silver explorer in Peru and then a graphite company in Mozambique and then a rare earths company in China and then a uranium company in Saskatchewan.
I realize that I was almost overwhelmed by choice and it was actually making my investing less successful and less enjoyable.
What I wanted was a way to focus my research, tune out the noise, and figure out how to become a better investor.
So I put together this simple chart as a starting point. I created 2 columns, “Preferred” and “Not paying attention”, and in these two columns I sorted jurisdictions and resources that I was interested in paying attention to and jurisdictions and resources that I’m not paying attention to right now.
By identifying which jurisdictions and commodities you’re interested in, you’re helping to focus your attention on some of the things that best capture your attention, which is a great place to start when looking at different investing opportunities. When I hear about a new gold mining opportunity in Ontario, I’m giving myself permission to take a closer look because it’s the jurisdiction and resource that interests me, so I’m presumably more familiar with the details. (Even if I’m not an expert, I am at least starting from a base of familiarity). If you’re familiar in just a few areas, you can make better apples-to-apples comparisons of mines that explore near each other… compared to learning what makes a good uranium mine in Saskatchewan and then having to relearn what makes a good molybdenum mine in Australia.
By adding something to the “Not paying attention” column, I’m not sweeping an entire continent or commodity into the trash can, never to look at them again. In fact, I do own companies that mine in these jurisdictions or work in the resources listed in the “Not paying attention” column. However, this chart serves to keep my euphoria in check when I hear about an AMAZING new exploration story. If it’s an aluminum mine in Asia, the chart is a reminder to me that these aren’t in my “Preferred” category so I need to do an extra check during my due diligence because I might not be as familiar with the jurisdiction or the resource. In the case of Flinders Resources (TSX: FDR) it was in a jurisdiction I was not as familiar with but I invested in anyway… I just needed to do some extra legwork ahead of time.
This chart also becomes a curriculum to help me learn to be a better investor. I can identify some of the jurisdictions and resources in my “Preferred” category and learn more about them. For example, I can see by looking at this chart that I’m woefully uneducated in the states/provinces of Mexico, Peru, and Argentina so that might be a good place to start. Or perhaps I can build on my interest in gold and dial in more information about gold-copper-zinc plays. And, I can do the same in my “Not paying attention” category. If I feel that I want to range out into a new jurisdiction or commodity, I can be more strategic in deciding what to look at next. For example, perhaps I’m willing to take on a little more political risk in my portfolio so I could look at some explorers in Africa or Asia.
I should also note that just because something is ON the chart doesn’t mean I’m invested in it. Copper is a good example right now. But it does mean that I’m familiar with the resource and that familiarity helps me trade more effectively. And I’ll keep an eye on copper for when I might find another opportunity that interests me.
A chart like this helps you to sort through the barrage of exploration companies, tune out the noise, and find exactly the kind of companies you are most likely going to get excited about.
You don’t have to just use the two categories – jurisdiction and commodity – that I’ve done here. There might be other elements you can also include to help you focus even further: Some others I might consider would be: Type of company (explorer, developer, producer, etc.), business model (prospect generator, mine-to-mill, etc.), market cap, stage in the mine lifecycle,
Due diligence. Everyone says you should do it but no one tells you how. I have started compiling a list of due diligence questions to ask yourself before investing in equities. This is not an exhaustive list. I’ll add more as I think of them. (Please suggest any questions you feel are missing).
There are a lot of questions here and I don’t think it’s realistic to ask yourself each of these questions every single time you plan to trade. But these questions follow a progression and some of the answers might not change from one review to the next. The important thing is that you are aware of each answer and that it informs your decision.
(Note: There are many other questions to ask – industry specific questions, and questions about investments that aren’t equities – so this should be a starting point for your due diligence but it likely won’t be the end-point… especially if you are investing in businesses or bonds or FOREX or real estate.)
What are your lifestyle goals? (i.e. What current lifestyle goals – like travel – do you have right now? When do you plan to retire? What kind of lifestyle do you want to enjoy in retirement?).
What are your financial goals? (i.e. How much money do you need to fund your lifestyle goals? How are you funding your current lifestyle? How do you intend to fund your future lifestyle? What other non-lifestyle expenses, such your child’s college education, do you also need to allow for?).
How do your current and near-term finances contribute toward these lifestyle and financial goals?
How do your long-term financial prospects look, especially in relation to your lifestyle and financial goals? (Consider job security, the likelihood of raises, etc.).
How are you handling the shortfall between your goals and your finance? (Almost everyone will have a shortfall. There’s nothing wrong with that. Some potential solutions include reducing expenses, increasing income, and making investments in businesses, equities, and real estate… just to name a few options).
What do you know about investing?
What don’t you know about investing? (Seems like a strange question but spend some time on it! It’s a useful thing to think about).
How would you describe your investing style? (i.e. Speculative? Value-based? Technical?).
What are the rewards of your investing style?
What are the risks of your investing style?
Who are your key investment influencers? (i.e. Friends, the media, blogs, etc.).
How do your investing preferences match and/or differ from your influencers’ styles?
What investments do you currently have right now?
What is the mix of investments? (i.e. How many equities? How many fixed income investments? What industries are they in? What is their weighting in your portfolio?).
How much money do you need to gain in your portfolio between now and when you need the money?
How much money are you willing to lose overall in your portfolio?
How much money would you like to gain on a single investment?
How much money are you willing to lose on a single investment?
What are the tax ramifications if your portfolio achieves your goals?
What are the tax ramifications if your portfolio declines?
What are the tax ramifications if an individual stock achieves your goals?
What are the tax ramifications if an individual stock declines?
Does your current investment strategy reflect your preferred returns and your preferred risk level?
How has your portfolio returned historically? (Consider overall, as well as year-over-year).
Can you identify what you might have done differently to increase your gains and minimize your losses? (i.e. What clues did you miss? Was your timing off and, if so, why? Whose advice should you have paid attention to? Whose advice should you have ignored?).
When it comes to investing, what would you say your biggest strengths are?
What it comes to investing, what would you say your biggest weaknesses are?
What type of investments do you prefer? (What size? What industry? Do your answers to this question match your answers to some of the earlier questions about the gains needed in a portfolio? Often they do not!).
What investments are on your watchlist?
Of the investments on your watchlist, why are they there? (Answer this question in two parts: 1. How did you first hear about them? 2. What raised your interest in them enough to put them on your watchlist?).
What industries are represented in your watchlist?
What industries are not represented in your watchlist?
At what stage are the industries represented in your watchlist? (Beginning? Growing? Plateauing? Declining?).
What are the strengths of the industries represented in your watchlist?
What are the weaknesses of the industries represented in your watchlist?
What are the opportunities of the industries represented in your watchlist?
What are the threats of the industries represented in your watchlist?
What companies are on your watchlist?
Why are these companies on your watchlist and not other companies in the same industry?
How long have you been watching them for?
Based on their historical pricing, do they match your financial goals? (Although history is not a guarantee of future performance, it can help indicate what it could be like. But of course it’s not the full story).
Do these companies match the level of risk you’re comfortable with?
Of the companies on your watchlist right now, why are you doing due diligence on this specific one? (i.e. What has changed recently to compel you to look closer?).
At what stage is your target company? (Beginning? Growing? Plateauing? Declining?)
What contribution does your target company make to its industry (Pioneer? Innovator? Follower? Commoditizer?)
What is the business model of your target company?
Who are the ideal customers for each company in your watchlist? (Consider gender, level of income, education, geography, etc.)
What is the value proposition of your target company? (i.e. What does the company sell? But more importantly, why do people buy this company’s products/services?)
Who are this company’s main competitors?
What are the main competitors’ contributions to the industry? (Pioneer? Innovator? Follower? Commoditizer?)
What are the main competitor’s stages? (Beginning? Growing? Plateauing? Declining?)
What are the main competitor’s business models?
Who are the main competitors’ ideal customers?
What are the main competitors’ value propositions?
What are the strengths of your target company?
What are the weaknesses of your target company?
What are the opportunities of your target company?
What are the threats of your target company?
Who are the decision makers at your target company?
What is the level of experience that each decision-maker brings to the company? (Consider both successes and failures, although remember that not all successes are necessarily good and not all failures are necessarily bad).
How might politics improve or take away from the target company’s successes?
How might the economy improve or take away from the target company’s success?
How might social values improve or take away from the target company’s success?
How might technology improve or take away from the target company’s success?
Can the company pay its debt?
How often does the company’s inventory turnover? How does it compare to others in the industry?
How long does the company’s receivables stay on their books? How does it compare to others in the industry?
What is the company’s debt-to-assets ratio? How does it compare to others in the industry?
What does the company do with its extra money? (i.e. Does it pay dividends? Does it re-invest? If so, how much?)
What is the company’s profit margin? How does it compare to others in the industry?
What is the company’s return on assets? How does it compare to others in the industry?
What is the company’s asset turnover? How does it compare to others in the industry?
What is the company’s net earnings per common share? (This is the Earnings Per Share – EPS – ratio). How does it compare to others in the industry?
How is the market valuing the company’s shares based on its EPS? (This is the Price-Earnings Ratio). How does it compare to others in the industry?
What is the company’s return on common shareholder’s equity? How does it compare to others in the industry?
What does the newsmedia say about your target company?
What are analysts saying about your company?
At what share price would you buy this company? (Why did you choose that price point?)
How do you want to benefit from this company? (i.e. Dividends? Capital gains? Safety?)
At what share price would you sell this company to achieve a desired gain? (Why did you choose that price point?)
What happens if the share price declines? How long will you hold it? How will you know when to sell?
What is the current price point of the target company’s stock?
What is the 52-day high price and low price of the target company’s stock?
Why has the stock price behaved the way it has in the last day, week, month, quarter, year, 5 years, and lifespan of the company? (“I don’t know” is not an acceptable answer here).
At what volume does your target company trade?
What external events impact your target company’s stock price and volume? (i.e. Some stocks are seasonal, other stocks are closely tied to a commodity, etc.)
Why this stock now? (i.e. What happens if you wait a day or a week or a month? What happens if you buy a competitor instead?)
When small business owners needed money to start and grow a business, they used to have three funding options: They could borrow against their own assets, could get a business loan or they could sell a portion of their business to family and friends.
Then the web opened up new possibilities with crowdfunding — a way for entrepreneurs to get their small business idea funded from angel investors. Kickstarter is one of the leaders in this space. With crowdfunding, angels would put money into an idea that they thought was cool or viable and when enough angels sent in money, the idea would be funded. In exchange for their funding, the angel would get the good feeling of having helped someone and they might get some kind of reward (like a mention on a website or a t-shirt or branded mug or something).
I really like the idea of crowdfunding a lot. It’s a way for entrepreneurs to get enough cash to start or grow. As an entrepreneur, I like that. But I’m also an investor and when I invest in businesses, I want to get a return for my money. Crowdfunding is cool but it doesn’t really provide a financial return.
Crowdinvesting is the next step: Once again, entrepreneurs present an idea and angel investors can fund that idea with cash… but now they get the potential of a financial return.
It’s an idea whose time has come! We have the technology and the payment systems and a ton of expertise available to people, plus I know many investors are looking for an alternative to the stock market and might see this as a viable opportunity.
One site that is pioneering crowdinvesting is ImpactCrowd. Here, investors can invest in 20 Euro segments to join a group of other investors and become partial owners in businesses. At this time, ImpactCrowd is pretty limited — they have a couple dozen ideas and only entrepreneurs from the Netherlands can post their idea and not all investors can participate (US-based investors cannot participate at this time but that should be changing shortly). But these things need to start somewhere and I’m glad to see it started.
I love the idea and I’m very excited about participating. In the interest of full disclosure, I’ll admit that there are bugs to work out of the system. But we’re on the verge of an exciting opportunity and I hope to see more crowdinvesting opportunities soon.
What are your thoughts? What opportunities and challenges do you see? Would you invest in a venture through a crowdinvesting site? Why or why not?