During the mining boom it wasn’t uncommon for investors to buy into half a dozen microcap mine stocks – aka penny hopefuls - at IPO at 20 cents a share, in the hope that the paydirt on just one would handsomely compensate for the remainder crashing and burning.
Admittedly, when all there is to go on is the ‘blue sky’ within a penny hopeful's prospectus, it’s hardly surprising why a lot of punters relegate the highly speculative junior explorers end of the share market, to a ‘put-it-all-on-red’ approach.
So what would it take to get in on the ground floor on the next Fortescue Metals (ASX: FMG) that comes to market, without feeling like you’re taking a wild speculative punt?
Azzet went looking for clues, and here's what we found.
Who’s running the show?
Ideally, you want to invest in explorers where management – notably the CEO, and exploration manager and CFO - has been instrumental in successfully bringing other resource stocks to market.
Find out if controversial characters are on the company's management. Likewise, find out if the company is in the courts, or has it changed its name in recent history?
Checking out the company's website should provide all you need to know about who’s running the company, the location of the company's project and its prospective resources.
Cash on hand
Depending on how long a company has been operating for, you should be able to look at how much cash the company has in its latest financial reports.
When looking at a financial report, you want to look at cash on hand.
Cash on hand is how much money a company has in its personal bank account; it is the same thing as checking your savings account the morning after a big night out.
If the company has only just listed on the market, go into its prospectus for the IPO (this should be on the website) and take a look at how much cash it raised, then subtract the costs it had to pay in fees to the lawyers and advisors.
Debt levels
You want to go back to the most recent financial report and figure out how much debt the company has — usually this will be a bank loan.
If a company has more debt than it has cash, that ultimately means it is a riskier investment, and there is a higher chance you will not make any money from the investment — or lose it all.
Note that cash on hand and debt are not the entire story of a company, and any configuration of these two sums can ultimately be irrelevant.
It's important to remember that while a recently listed company may not have any debt, it could likely take on debt in the near future.
You want to keep in mind how much money a miner has to explore with, and whether or not it is likely to borrow money in the coming months.
Boots on the ground
The next thing to check is what the company is actually doing.
This is important for junior explorers, because a lot of them take years to get going.
If a company’s only plans for the next twelve months are to secure regulatory approvals, there’s good chance your money will be exposed to a higher volatility risk.
In other words, the share price could fall in shallow trading if impatient investors find a better junior miner to invest in.
It’s also important to remember that while junior explorers are ultimately trying to confirm beyond doubt high volumes of commercial minerals at a project location, that doesn’t mean they’ll go on to become producers.
Corporate activity
It’s not uncommon for junior explorers to either end up selling their discoveries to larger companies or bringing in partners as a project advances into production.
If a company has found high grade cores containing gold and copper and has sufficient cash to immediately launch a further exploration campaign, there is greater likelihood of the share price rising as more investors buy into the stock.
It’s equally important to remember that junior mine stocks can rise and fall on shallow trading based on future company announcements.
That’s why you need to understand what a good mine discovery looks like when you see it.
Admittedly, decoding mining drill results, from core sampling to grade analysis isn’t rocket science. But understanding when a gold miner, for example, is sitting on a valuable find will require a bit of homework.
Once you know what a good result looks like, you’ll have the confidence to put in a buy order before the market opens, knowing there's a strong likelihood that the price will rise at the open.
But don’t forget, even if the share price rises 15% at the open, that increase may unravel during the day as profit takers head for the exit.
Share market noise
Given that junior explorers attracts people having a speculative punt, it’s wise to exercise extreme caution when entering online sharing forums.
Make sure your BS radar is on at all times and be prepared to invest time reading company materials and other relevant information.
If you simply don’t understand a company announcement, call the number at the bottom of the release and ask for clarification.
More often than not the CEO’s name will be at the bottom of the release and he or she should be only too happy to answer your questions.
Given that junior mining stocks tend to be highly speculative plays, identify how much money you are willing to risk right from the get-go.
