He may be the investing legend of all time… Warren Buffett.
Along with his long-time partner Charlie Munger, Buffett created an investing juggernaut that has beaten returns from just about every other resource. Over the course of the nearly 60 years Buffet has been at the helm, BRK has returned an insane 2,419,900%!
That blows away the S&P 500 by over 100x.
And he’s done it all by being a disciplined value investor. By buying solid companies he believed were undervalued.
When he finally departs this earth, “Greatest Value Investor Ever” will be etched on his tombstone.
Anyway, understanding the valuation of a company has been the secret to all Buffett’s success.
Berkshire Hathaway owns 40-some companies across a range of industries. But what he doesn’t own are any mining interests. No majors. No royalty companies. And CERTAINLY no juniors.
It’s not hard to understand why.
Buffett is all about buying value.
And mining companies are notoriously hard to value.
Hard.
But not impossible…
Three Ways to Think of Valuation
Calculating valuation metrics for mining companies generally involves a lot of geeky math. (Which we won’t dive into for you math-o-phobes.) But understanding the basics is much easier. And that’s what we want to lay out for you here.
Essentially there are three main valuation methods that are used in the mining industry.
P/NAV
The most widely used method of valuation is known as the Price to Net Asset Value (P/NAV) method. The net asset value of a company is also known as its “net present value” or its “discounted cash flow.”
Put another way, it’s the dollar amount you’d receive if a company liquidated all its assets and paid off all its liabilities (debt).
The simple formula for this calculation is Market Capitalization / (Net Present Value of all its assets – its Debt). (Where market cap is share price x the number of shares outstanding.)
This will show an investor what the share price of a miner is trading for compared to the total value of its assets. Miners, especially gold miners, typically trade at a discount (below 1) to their NAV.
A second method is known as…
EV/Resource
This is the Enterprise Value to Resource method.
The enterprise value of a company is a measure of its total value. This goes beyond simple market cap. Enterprise value considers the market cap of the company but also factors in short- and long-term debt as well as cash and cash equivalents on a company’s balance sheet.
This value is then compared to the total amount of mineable resources the company owns.
It’s pretty straight forward. But investors take note, what this formula doesn’t take into account are actual mining costs (the costs to both build a mine and extract the ore).
This method can be more helpful for valuing early stage mining companies where mine output is nonexistent.
Finally there’s…
TAC
This refers to the Total Acquisition Cost method. This estimates the cost to buy the asset and build and operate a mine on a per ounce/pound/metric ton basis. (Whatever the ore’s standard production measure is.)
This calculation involves some advanced assumptions about the situation.
Say for example you’re looking at a company with a market cap of $10 million sitting on 2 million ounces of silver. You could purchase the asset for $5 per ounce. Now, based on studies you’ve done, you know it’ll cost you $10 per ounce to build a mine and then $5 per ounce to operate it once it’s up and running.
Add it all together and you get $20 per ounce of silver. You compare this to the market price of the ore. (Generally any TAC below 80% of the spot price is a good value!)
The Tricky Part
Valuing a typical manufacturing company is all about estimating future revenues. Their ability to produce (or purchase) and sell a product. Fairly straight forward.
But mining companies, especially early stage miners, come with unique challenges.
The key point to valuing a mining company is being able to get a handle on the mineable resource potential of their deposits. In other words, how much ore can they ultimately mine and for how long can they mine it.
In the case where you can’t discount future cash flow (i.e. where there is no revenue being produced) getting an as-precise-as-possible estimate of the asset’s value becomes critical. And for junior miners, that means watching drill results as they’re produced.
Again, valuing a mining company is a tricky business — something even the Oracle of Omaha would admit!
But understanding these basics, you’ll know where to look to intelligently evaluate a mining investment.