How I Pick Stocks

Silver Stock Report

by Jason Hommel, October 15, 2007


Here’s how I evaluate junior exploration stocks: 

The things I look for are very basic; essential when shopping for any good deal.  There are only two main questions.  What is the price? And what do I get? 

The price is the market capitalization, not the stock price.  The market capitalization (or market cap) is the valuation of the company if you could buy all the shares at the current stock price. 

Market cap = number of shares x stock price.

When you buy stock in a company with a $20 million dollar market cap, you are essentially saying, “Yes, this company should be worth $20 million dollars or more.”

Here’s another way to understand the market cap.

If one company has a stock price of $2000 per share, and only 1000 shares issued, that’s the same market cap as a $.20 stock price with 10 million shares issued.  Most people don’t seem to realize that.  Most people think that a stock with a share price of $2000 per share must be the overvalued company, but the stock price has nothing to do with it.  In reality, unless you know how many shares have been issued, you have no idea of the value of the company. 

I’ll say it another way:  The share price says absolutely nothing about whether a company is cheap or not, unless you know how many shares have been issued.

Trying to buy a “penny stock” at a $.11 share price says nothing about whether the company may be cheap or not, because they might have already issued 650 million or even billions of shares!

It’s even more complex, because there are actually several different ways to calculate a market cap!  It also depends on the warrants and options.  If a stock is trading at $2/share, warrants or options at $1 are called “in the money”, and will likely be exercised and converted into shares.  However, warrants at $3/share may expire worthless and go unexercised, and might not be converted into shares. 

So, you have to look at the entire share structure, and take a look at the strike prices and expiration dates of the warrants and options.

The figures that I usually work with are the “outstanding” shares and the “fully diluted” shares.  I usually count all the shares fully diluted, which includes all warrants and options, because the only reason I’d buy a stock is for the bullish outlook, and under that assumption, I’d typically assume most or all warrants and options will be converted (and even more will be issued, as necessary).  That’s what I do to simplify the matter.  It also helps me err on the side of caution, since it makes the company appear more expensive this way.

Shares “authorized” is something different.  That is the total number of shares that the company could issue, without having a shareholder vote to increase the number. 

To find out the number of shares fully diluted sometimes takes a little work.  You can sometimes find a current number listed at a company’s web site, that’s the fastest way, usually under “quick report”, or “share structure” or “company info”.  Or, you can look up the financial reports.  Then, you need to check the date of that number, and scan the news releases from that date until today, to see if any more shares have been issued through stock options, or any recent financings.  Add up the numbers, then multiply by the share price, and that’s the highest market cap.

Stock Price = SP
Fully Diluted Shares = FDS
Market Capitalization = MC

SP X FDS = MC

And remember to keep continuous track of the market cap as long as you own the stock.  I recently saw one company issue $80 million worth of new shares at $.50/share, which surely doubled the market cap, and removed a lot of the upside potential of the stock, because there’s no way that they could spend that much on exploration in a single year.  

I usually like to look at companies with market caps in the range of $50 to $100 million and under; usually, the lower the better.  Thus, a true penny stock does not depend on the share price, but rather, the size of the market cap! 

But I don’t just buy all companies with a tiny market cap, which can also be dangerous.  Share price is also important.  I don’t like to buy stocks under $.20/share.  Many people in the U.S. pay 1 penny per share in commissions, and at $.10, that’s a 10% hit, which is rather steep, even steep at 5% on a 20 cent stock.

Excessively low share prices are a strange curse of the Canadian mining industry. 

(A hundred years ago, the average stock price in the U.S. was about $100.  Since the dollar was worth about 50 times more back then, that’s about a $5,000 share price equivalent.  That’s a stock price that would make sense, because people would consider a single share as a real investment.) 

But the market tends to give people what they want, and investors get what they deserve, as we are often reminded by Bill Bonner of the Daily Reckoning.  Foolish investors who don’t understand market cap, and who just want a “cheap share price” have created an odd type of demand that the mining industry has served by creating company share structures that create stocks priced under $1/share.

But “serving the (foolish) market demand for penny stocks” has two major trade barriers for the companies that have engaged in it. 

First, there is the 1 penny commission that many brokers charge, which amounts to a 10% commission to their potential stockholders on a ten cent stock. 

Second, many American institutions have charters that prevent them from buying stocks that are priced under $5/share.  And furthermore, many brokers at major brokerage houses in the U.S. are forbidden from even recommending stocks priced under $5/share.  Thus, Canadian companies who want to avoid catering to foolish investors would do themselves a big service if they did reverse splits to get their share prices into the $5-10 range.

The exploration industry may complain about lack of analyst coverage, but many analysts cannot cover the stocks; simply because the stock price is below $5/share! 

But I’m not complaining, only observing.  In fact, because I see how things ought to be, and see how things are, I see the opportunity as clear as day.

The Canadian mining company’s ignorance or neglect of Wall Street’s protocols, and Wall Street’s neglect of Canada’s mining industry, is part of the reason we have such a great opportunity, and why the stocks remain cheap.

Low priced Canadian stocks, hurts them, as they restrict their own access to capital.
Wall Street’s failure to buy stocks below $5/share hurts them, as they lack the great investment returns.

Both industry’s failures hurt them, but help me and my readers, as we are able to capitalize on their failure to encourage trade to take place. 

So then, I track the market caps (based on the share price and share structure) of nearly 700 mining and exploration stocks at miningpedia.com.

—————–

Finally, to discuss the other main issue when considering an investment.  What do you get for your money?  What does the company have?  A $1 to $5 million market cap might be pricey if they don’t have a great land package.

I like to buy leverage.  I want the most for my money.  Therefore, I look for superlatives.  The highest grades.  The biggest projects.  The best location.

I do not like to buy unknown exploration potential.  I like to buy freshly drilled resources that are higher grades and bigger projects than the market seems to realize and recognize. 

Not all projects will ever get funded to production.  Many of the projects in the natural resources sector are 30 years old, or older, but are now finally ready to go to production!  Some of these are now becoming potential winners.  The projects that will be the most likely to attract major funding are those that tend to be the biggest, with the highest grades.

I tend to want to stay away from the smaller projects, with marginal grades, that will still require $50 to $100 million to be put into production; that may never get funded.

I also like to stay focused on location; primarily within North America.  Latin America is turning increasingly towards confiscating mining projects again.  I’ve seen problems with Honduras, Bolivia, Ecuador and Peru in just the last 3 years.  Remember that about 70% of the world’s oil is being produced by national governments who have confiscated the discoveries.  This is why less oil discoveries are being made, in my opinion; due to world communism/confiscation.

The money moves into the mining sector in big waves.  As it leaves, and stock prices drop, the sector seems to get sleepy, and people stop paying attention to the news releases.  This is the time to stay awake and do a lot of research, and see which projects are moving forward the fastest.

Some people say that this is a people business.  I don’t know about that.  When I buy silver, I’m doing that because I think most people are fools who foolishly hold too much fraudulent paper money and bonds, and overvalued houses, and overvalued stocks.  I’m not betting on people, I’m betting that people are foolish, because so few own silver. 

Most mining or exploration company executives do not own silver.  That’s already one major strike against them, showing how foolish they already are.  Furthermore, no miners are even attempting to use silver as money, as a company; as a place to put company funds, nor are they offering to pay employees in silver.  How utterly foolish.  Again, strike two.  So, if I had to bet on mining people, I wouldn’t bet on any of them! 

So, I don’t think this is a people business.  Instead, I think this is a numbers business.  A good track record means little to me.  I reason, “Just because you have discovered something in the past, is no guarantee that you know what’s under the ground in the next area.”  Furthermore, if an explorer has a great track record, then he’s probably got plenty of investors ready to follow his moves, and bid up his stocks excessively.  I’d almost rather invest with a man who does not have a great track record, has difficulty finding funding, and has problems promoting his company.  Because those things can be fixed, and you can hire people to take care of that, if the project is good and worthy. 

The best people (explorers and developers), and money, will gravitate to the best projects, as I’ve seen time and time again.  And sometimes, the money gets there first, and that’s what I try to do.  Otherwise, you are a follower, and the later you get there, the more you pay.  That’s the way it works in this “first come, first served” world we live in.

So, in conclusion, I like a low market cap company, with plenty of drilled up resources located in North America, run by guys who are poor promoters.  That sounds like two of my top three stocks for 2006, which rose about 200% & 400%, in 2006.