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Mining shares – what to look for

We look at what investors need to know when looking at mining shares.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

Last week, we looked at banking shares and what investors should look for in a set of results. This week, we turn our attention to miners. Headline numbers like revenue, profit and debt are often readily available in earnings reports. But if you want to gain a real understanding of how the business is performing, it’s useful to be able to dig a little deeper.

We look at key concepts for mining shares that set them apart from other sectors.

Safety

Mines are dangerous places, but those that run them have a responsibility to make sure they’re as safe as possible.

The largest miners will all report on the number of fatalities at mines they run. The target, of course, is zero. And you’ll often have specific safety related commentary to go alongside more traditional topics. Any concerns can become a major issue for miners, and in the worst case could cause operations to be shut down. So as an investor, it’s always worth looking at.

Digging stuff up and selling it on

At the most basic level, miners dig and sell what they’ve mined for more than it cost to get it out the ground. But not all mines are the same, and not all operations have the same costs.

It’s important to look out for any commentary on how much it costs to pull the materials out of the ground. This is the unit cost of production and it’ll vary from mine to mine. Comparing this to the current market price gives an idea of how much wiggle room there is in pricing.

A miner with lower costs of production than its peers will benefit more when prices rise, but should also stay profitable for longer if they fall.

Miners don’t control the price they sell their goods at. Commodity prices are driven by supply and demand. If demand rises thanks to, say, a booming economy, then the price will rise and vice-versa if conditions turn. That means production costs are key when considering how a group might perform under different conditions.

What you’re digging for matters

It’s easy to lump all miners together and assume they all do the same thing. While they run mines and dig things up, what they dig up differs. The larger players will likely have more diversified income streams, meaning they operate a variety of mines producing different materials.

It’s important as an investor to understand what the company is digging for. A company that relies heavily on iron ore is very different to one making most of its sales from gold. Not all commodity prices rise or fall in tandem, so it’s important to understand where the cash is coming from.

Don’t worry, you won’t have to guess. Miners detail exactly what they’re digging for, and the revenue and profits from each segment, in their annual report.

Mines are expensive  

Building a mine is no small feat, it takes a lot of investment. Financing these projects means either issuing new shares, which dilutes existing shareholder value, or increasing debt.

Debt needs to be repaid no matter how commodity prices are doing. So, it’s always something worth keeping an eye on. We like to use debt/total assets when comparing the debt levels of mining stocks. As with all financial ratios, it’s important these are used to compare similar companies, but also that they’re not just looked at on their own. 

A ratio greater than one means the company has more debt than assets, which could be a sign it’s overreached. Given miners have large amounts of assets, they can stomach a good chunk of debt before that ratio starts to raise a red flag.

Valuation

There are lots of ratios investors can use when it comes to trying to work out if a company is over or undervalued. And depending on the company in question, some can be more useful than others.

Reliant on commodity prices, miners’ earnings are cyclical – they ebb and flow with how well the economy is doing. And when earnings are cyclical, traditional valuation metrics like price to earnings might not be the best.

For miners, we prefer the price to book (PB) ratio. A company’s book value is its assets minus liabilities, or total equity – which can be found in a company’s balance sheet.

PB = market capitalisation / total equity

It tells us what a company’s worth relative to the sum of its parts. There’s no hard and fast rule as to what’s ‘good’ or ‘bad’, we use this to compare against historical averages and other companies in the same sector. This ratio typically works well for companies that have large amounts of assets on the balance sheet, like property and machinery for miners.

Another metric worth looking at is the EV/EBITDA. This looks at a business from the perspective of a potential buyer. It considers the enterprise value (EV), which is the market capitalization + debt - cash and equivalents, to EBITDA (earnings before interest, taxes, depreciation & amortization).

The ratio tells investors how many times EBITDA they’d have to pay to buy the business.

Valuation metrics and ratios are useful when it comes to evaluating stocks but they shouldn’t be used on their own. For example a low valuation ratio could signal good value, but it could also be a red flag. It’s important to look at the bigger picture.

Don’t panic

It might seem daunting the first time you pick up a miner’s annual report, but that doesn’t mean you can’t have a good grasp on the business. And it’s important that you do. No two miners are the same and understanding what makes them tick is essential to making an informed investment decision.

We know not everyone wants to do the all legwork themselves. If that’s you, our share research can give you expert insight straight to your inbox to help with your investment decisions.

Investing in individual companies isn’t right for everyone – it’s higher risk as your investment is dependent on the fate of that company. If a company fails, you risk losing your whole investment. You should make sure you understand the companies you’re investing in, their specific risks, and make sure any shares you own are held as part of a diversified portfolio.

All investments and any income they produce can fall as well as rise in value, so you could get back less than you invest. If you’re not sure an investment is right for you, seek advice. Past performance is not a guide to the future.

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    Important notes

    This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

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