Global gold stocks review & valuation: US & Canada

Value Short-List

Since this is an earnings based valuation model, I've excluded companies which are expected to be unprofitable over the next two years and those which are not currently producers.

Earnings Based Models for Valuing Gold and other Resource Stocks

I use an earnings based valuation model to obtain estimates of underlying business value to assist in finding companies for investment at prices significantly less than their value . As a shareholder of a business, you generally want good return on your capital, low dilution of your shares, and growing profitability with strong incremental return on reinvested profits. Some people like dividends, but I think that it is a personal preference. Generally high levels of profits being paid out in the form of dividends means that there are few profitable opportunities to reinvest profits back in to the business.

I believe that to be successful over long periods of time the trick is to be able to see where earnings are headed and to find the big trends. I think that it is also appropriate to use an earnings based method for valuing producing resource companies, which goes against what others believe. Many consider EV/Resources or EV/Reserves a good way to compare companies and determine relative value. However for me this doesn't make a lot of sense. I'm not saying it doesn't work, but it doesn't fit within my view of how the world works. I'll explain.

As an investor, I can choose to put my capital at risk if I expect that I can derive a rate of return greater than the risk involved. This return can be in the form of profits that are reinvested back in to the business or as a return of capital via dividend or other form. This is the key point. I need to have a certain rate of business revenue, less cost of operating the business, to derive a profit. You can put this down as a stock versus flow argument.

"A bird in the hand is worth two in the bush"

If I invest in a producing mining company my intent is profits. I want the proverbial bird in my hand and not left out in the bush. I'd also like it sooner rather than later, you know, the whole time value of money concept. In a cyclical commodity cycle and long term gold bull market, I definitely want the stuff in the hand.

Why is this? A bar of gold in the  hand is worth more than nuggets in the ground.  The reason for this is two-fold. Firstly, the gold in the hand is de-risked, whilst the gold in the ground may have difficulties with extraction and price of extraction may increase due to rising fuel costs, labour costs and so on. Secondly, the gold in the hand has optionality. It can be stored and utilised at any time. It can be sold and used to transact and acquire another business, it can be used to acquire new tenements which have known reserves or for greenfield exploration. It can be used to pay dividends, buy back shares, pay down debt.

This leads us to the flow argument. A producing mining company has flow as well as stock, while an explorer has only stock. Things change: commodity prices change, regulations change, governments change... you get the point. If you can get the flow out of the ground as quickly as possible at the lowest possible cost, you have something of real value. If you cannot get the flow out of the ground as quickly as possible and the cost is unknown, or at worst uneconomical, you have a potential liability on your hands. The former is desirable whilst the latter leads to capital raising in the form of more shares or more debt. When investing in mining companies, I'm actually investing in the flow and not the stock. 

But what about the mine life, you may ask. Surely if the mine life is expected to be short this is a bad thing, right? Well, given the value of flow over stock, this isn't as great a concern for me. If I'm investing in a company which is focusing on getting the metals out of the ground quickly, with low cost, profitable, strong cash flows and a demonstrated ability to do what they say they will do, what would stop them from purchasing another company that has less effective management or further tenements with known reserves that they are able to economically extract? This is the business side of the operations that I think is under-appreciated compared to the reserves. As with all businesses, effective management can lead to great things whilst valuable resources can be ruined with poor management. This is the key and this is why I value the flow of production over stock in the ground. From this point of view, you don't need to worry about the fact that individual resources are not infinite.

Companies included:
Barrick Agnico-Eagle Alamos Allied Nevada Argonaut Aurizon AngloGold Aurico B2Gold Centamin Centerra CGA Couer Claude Crocodile Colossus Drdgold Eldorado Franco-Nevada Freeport Goldcorp Great Basin Gold Fields Rangold Harmony Hecia Iamgold Jaguar Kinross Kirkland Minefinders Newmont New Gold Northgate Nevsun Oceana Osisko Perseus Royal Rubicon San Gold Semato Yamana