Monday, October 15, 2012
It was impressive...
A few years back, I sat down with billionaire resource investor Rick Rule to see how he worked out the value of a junior mining company. We worked through several pages of drill results, highlighting good sections.
Then... he looked up... and gave me a number.
It was a lot like the owl from the old Tootsie Pop commercial: "One, two, three... crunch." After 30-odd years in the business, Rick can wade through all that data and get to the value at the center. But not many people can.
Fortunately, the playing field just got a lot more level.
Until last year, it was nearly impossible for a typical investor to figure out a value for a junior mining company. Even analysts had trouble... Unless you are a mining engineer, it is difficult to distill a series of drill holes into a share price number.
But in 2011, Canada – the center of the universe for junior mining companies – implemented the National Instrument 43-101 (NI43-101) regulation of mineral claims. Included in this bundle of rules is the Preliminary Economic Assessment (or PEA).
And if you ever trade small commodity stocks, you need to know how to use it...
The PEA is a brief study that outlines the economics of turning rocks into money. And it is enormously helpful to investors.
A typical PEA summarizes a specific project. It details the geology, the work performed, and the resources. Most importantly for valuing a project, a PEA outlines the costs and financial assumptions of the project... and often includes something called the discounted net present value (NPV).
An NPV is just an accountant's way of putting a value on an asset that won't pay investors for years. That's useful for prospective mines that won't be in production for a long time.
The NPV gives investors a reference point for valuing a project. For example, earlier this year, when mining companies were hated, many companies traded for far less than their NPV. Then, as the gold and silver prices rallied, they soared.
That's not to say that an NPV is always exactly right. It isn't. It includes all sorts of assumptions. A company could use a very high gold price and very low interest rates to boost its value. Or it could use a very low grade to determine its ore zone. These tricks are something you must watch for... but they get easier to spot over time. And doing your homework is key.
A PEA isn't a panacea, but it is an excellent reference point for investors. It aggregates all the information on a project into a single report. It gives you a starting place for figuring out the value of a company. And they are easy to find. If a company has one, it will come out in a press release and be prominent on the website.
The PEA is now one of my favorite tools for reviewing companies. If you're interested in junior mining stocks, it should be one of yours as well.
Matt's shown you other "tools" you need to do the job right. Last December, Matt published a "how to" series on resource investing. He showed you how to master the sector's booms and busts, the tools you need to make the proper trade, how to maximize your returns and reduce your risk, and the single most important factor in all of natural resources.
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