Jul
22

How Best To Evaluate A Gold Mining Stock Investment

Evaluating gold mining stocks takes a somewhat different approach to picking other types of stocks such as growth ones.

Commodities like gold are largely cyclical – that is, they experience highs and lows in cycles. Getting your timing right can be as equally important as picking the right mining stock. It brings to mind the old adage “all ships rise with the tide” – in a booming gold market, where gold prices are sky high, almost all stocks will benefit from the cycle (often even those that are not particularly sound). Equally, when gold prices are low and heading south even quality gold miners may suffer in terms of their stock price. This is why getting the timing right is important with mining stocks.

Here are some important factors when evaluating a mining stock:

1. What Is The Actual Value Of The Gold Stock? “Market Cap” is the mainstream way of valuing a company. But with miners dig a little deeper and figure out what the net asset value of the stock is. If it went bust tomorrow, what would the company be sold at? How much would it’s assets minus liabilities actually fetch?

Market Cap can be calculated by multiplying the number of shares by the market price per share. But, if the net asset value of the company is a fraction of market cap, then it could be a risky investment – particularly if things turn sour for the company.

By making sure that the net value of the company is close to the market cap value, you’re getting more value and reducing your risk with your investment.

2. The Management Is Key – We know that management is a crucial element of success within any company. However, it could be argued this is even more so for companies like miners, where industry specific knowhow is key.

If the management team within your potential gold mining investment is a proven winner – and they have created success stories with other miners, there is an element of security in that. If however your management team is unproven, or worse have failed in other companies then that is something to be wary of. Do research on the people at the very top – it can be a sign of the direction your mining stock could go.

3. Look For Cash Reserves – Mining in any industry is a cash intensive operation. Exploration, obtaining permits and the physical extraction process swallow huge sums of cash. Is the miner well placed for cash or will it have to run to the bank or other shareholders to raise money for future projects. If it’s the latter, there could be negative pressure on the stock price.

4. Analyze Annual Reports & Broker Research – Arguably, you should do this for any stock you potentially buy, but within the context of mining stocks, the tone of the annual reports (is it very bullish with lots of ambition and clearly defined strategy?) as well as what brokers believe the stock will achieve. Brokers are paid to be able to estimate future earnings and in turn they are best likely to be able to judge what levels of metal (etc) the company may be able to mine.

5. Low PE Ratio – Companies with Low PE ratios typically have lower to fall in case anything goes wrong (and with Mining stocks, they often do) – sound fundamentals should also be sought, including low debt, and good cashflow.

6. Exploration In Low Risk Areas – Many mining companies have lost value in their stock price because they try to extract their commodity from a politically unstable location. Such locations can be difficult to obtain permits from, and the fragile nature of their politics means the company can be subject to sudden changes that can lead to it abandoning projects at huge losses.

7. Good Prospects In The Pipeline – The company should have some exciting projects in the pipeline.

If you stick with these basic rules, then you will improve your chances of adding only the best gold mining stock prospects to your portfolio.

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