Evaluating Mining Stocks: Discovery Investing

This article was originally published on Gold Investing News on March 30, 2011.

When considering investing in junior mining companies many factors must be taken into consideration. The majority of junior mining companies have no revenues or cash flows which makes evaluating them with traditional methods used for established companies less than ideal.
Gold Investing News spoke with Chris Berry, founder of House Mountain Partners, for their take on evaluating junior mining companies. Mr. Berry’s company has created a system for evaluating junior mining companies who lack the reputation of larger firms that have been established in the industry.
“We have pioneered an investment philosophy called ‘Discovery Investing.’ It’s a different approach to risk and is a road map that lends itself nicely to micro and small cap companies. We believe that all wealth creation begins with a discovery, whether it’s a gold deposit or a cure for cancer. With that in mind we look at 10 factors that are designed to evaluate junior companies,” stated Chris Berry.
In this article we will look at some of the most important aspects of discovery investing in determining the value and risk associated with investment in junior mining companies. The first of these is the main asset of the company you are evaluating, the size of their deposit. “Is this a world class deposit, is it a company maker? This is based traditionally on the grade and tonnage, and other intangibles such as the location of the deposit,” stated Berry.
The location of the deposit is also an important factor in determining investment; more specifically, is the deposit  in a mining and business friendly environment? “If you have two similar deposits in terms of grade and tonnage, but one is located in Quebec, for example, and the other is in a central African country, then in my opinion the deposit in Quebec should have a higher valuation. This is due to geopolitical intangibles, such as the threat of expropriation and political instability,” stated Berry.
The ownership of the deposit is the next factor to consider. The control that the company in question holds over a deposit weighs heavily on future profits, and takeovers. What an investor should be looking for is if the company owns 100 percent of the asset and has no underlying royalties that they have to pay. Those types of deposits are somewhat rare, but it’s a best case scenario. In joint ventures you want to look at what the partner brings to the table, if they bring financial muscle, then that can defray potential share dilution,” stated Berry. A joint venture partner may also add its technical expertise to the venture which may be beneficial given the circumstance.
The experience and quality of the management may be one of the most important factors in considering investment in a company. Management can make or break a company’s long term potential. In relation to juniors that are looking to start production on an asset, it is beneficial to know if the management team has gone through the procedures before.
“The experience of management is key. Does the management have the financial and technical know-how to take a mining project to production if that is their stated goal? Generally, the longer management tenure in the mining industry, the better,” stated Berry.
The most efficient way to determine the expertise of the management team is to go directly to the company’s website to research the background of the officers. Mining companies welcome inquiries made to the Investor Relations staff concernint the company’s management background and other specifics of the firm.
The potential and the immediacy of production on the deposit is essential to realizing profits. The longer the process to get a mine into production, the greater the courage and patience of the investor to wait for cash flows to be generated.
In practicing due diligence the investor must determine if the project is a “new discovery where the company is ten years away from getting to production due to permitting and environmental studies, for instance. Or is it a company that has acquired a past producing mine in a good mining district that  can monetize their asset more quickly,” stated Berry.
Looking into a company’s financial footing, especially in regards to juniors, is challenging as many of them have yet to begin generating cash flow. The financial soundness and sustainability of a company is an important aspect in determining investment.
“In the junior space, the one metric used for financial evaluation is ‘enterprise value.’ That takes the market cap of a company, adds in any debt, then subtracts out the cash. The reason why this is used is that enterprise value is typically referred to as the potential take-over value of a company,” stated Berry, adding, “if the company has a JORC estimate or a NI 43-101 resource estimate, then you can tell what the size of the resource is that company thinks they have in the ground. You can then do the math to determine what the company is worth relative to its peers in the market.”
In determining the value of a junior miner, take these criteria into consideration. Many are generating cash flow from producing on their deposits; in those circumstances traditional metrics on a company’s performance is a valid approach. It is up to the individual investor to practice due diligence in determining the merits of individual companies. When considering investment in firms that have yet to start production on their deposits it is also on the investor to have the fortitude to stay with a company with a lack of cash flow, and to be weary of companies that do not follow through on their promises and targets.