In my first two posts on junior mining red flags, here and here, I laid out a dozen red flags to look out for in the junior mining sector. Those dozen rules are fairly straightforward and I believe they will help an investor stay away from the majority of big pitfalls in this sector. In this third and final installment of the series I want to focus on the importance of a company's share structure.
A company with a great project and a terrible share structure and poor capital stewardship by management will inevitably be a poor investment for shareholders. Whereas, an excellent share structure (tight with very little cheap stock out) and good stewardship by management will allow a company with mediocre projects to go a long way until they are able to find/acquire a great project. If there were going to be a red flag #13 it would be poor share structure and poor capital stewardship by management (the two often go hand in hand).
Share structure is multi-faceted and nuanced - here are some of the most important things that I look at for every company that I analyze:
- The number of shares a company has outstanding. In early stage exploration companies I really like to see companies with less than 50 million shares outstanding.
- How many options or warrants are outstanding and what is the exercise price and expiration date of these options and warrants?
- Who owns the stock? Is it mostly in the hands of retail investors or does management and institutional investors hold the majority of shares? We'd rather invest in a stock that is largely held by "stronger hands" i.e. insiders and institutions who aren't looking for a quick flip for a 20% gain.
- What prices are people in the stock at? I think this is really key. If everyone got their shares for a penny they are probably going to be much more willing sellers in the future than if they paid market prices for their shares.
- We would also prefer to hold shares in companies with relatively tight share structures i.e. less than 100 million shares. The number of shares outstanding usually has a lot to do with what stage the company's projects are at, however, when companies get into the multi-hundred million share levels it usually means they've raised a lot of money over time and created a lot of underwater shareholders in the process. Simply put, tighter is better.
I want to invest in companies where the management feels a sense of urgency to make progress and create shareholder value. Junior mining stocks are burning matchsticks, I want to be a shareholder in a company that gets this notion and realizes their window of opportunity isn't infinite. Every month that nothing is happening the company is burning another $50,000+. I also don't want to hold shares in a company that burns through cash without much care or thought in an attempt to create an illusion of activity (either via excessive promotion or through reckless acquisitions or exploration).
There is a fine line. We don't want zero activity and no progress, but we also don't want a company to push too hard before the fundamental story is ripe i.e. doing a ton of promotion when there isn't much fundamental news to substantiate it or spending a ton of money on drilling when the market isn't rewarding companies for adding ounces/pounds etc.
The junior mining game isn't incredibly complicated. Sure, there are many variables and moving parts but at the end of the day it boils down to cash and shares; investors are buying shares in a company in exchange for cash, and the companies are issuing shares to investors in exchange for cash they use to operate and explore. Investors can also exchange their shares back for cash by selling, and our goal as investors is to sell our shares for more than we paid for them. One of the easiest ways to accomplish this feat of share price appreciation is to invest in companies that take their shareholders seriously by being good stewards of shareholder capital.
The more cash a company burns through the more shares typically get issued, this is dilutive and tends to weigh on the share price (especially over the long run). The lower a company's share price the more shares the company needs to issue in order to raise the capital it needs. This cycle of dilution can be a vicious one for a company that has negative momentum (not much positive news and a solid downtrend in its share price). Good news and good management usually results in a higher share price and less share dilution, poor news and poor management usually results in the opposite.
Avoid the big red flags, follow the best management teams, and manage risk by not becoming too heavily invested in any single stock (regardless of how good we are at picking stocks we're going to occasionally buy a real lemon, it's the nature of the game). Oh, and one of my readers reminded me to be skeptical and not believe in US$750 million all-cash takeovers of C$20 million market cap micro cap magnesium exploration companies. If it looks ridiculous and too good to be true it usually is....
DISCLAIMER: The work included in this article is based on current events, technical charts, and the author’s opinions. It may contain errors, and you shouldn’t make any investment decision based solely on what you read here. This publication contains forward-looking statements, including but not limited to comments regarding predictions and projections. Forward-looking statements address future events and conditions and therefore involve inherent risks and uncertainties. Actual results may differ materially from those currently anticipated in such statements. The views expressed in this publication and on the EnergyandGold website do not necessarily reflect the views of Energy and Gold Publishing LTD, publisher of EnergyandGold.com. This publication is provided for informational and entertainment purposes only and is not a recommendation to buy or sell any security. Always thoroughly do your own due diligence and talk to a licensed investment adviser prior to making any investment decisions. Junior resource companies can easily lose 100% of their value so read company profiles on www.SEDAR.com for important risk disclosures. It’s your money and your responsibility.