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In this video, I go over the basics of interpreting financial statements for mining stocks.
For a much richer look at this subject, see our collection of videos on Reading Financial Statements for Stock Selection.
The basic points addressed in this video are as follows:
1. The purpose of reading financial statements is to help us identify the best and most promising companies; those with the best shot at having the most profits. Such companies have the most share price appreciation and thus benefit investors accordingly.
2. Financials should be viewed in a relative context; relative to other companies in the mining sector and companies of similar sizes. Because of this, when you are looking to make investments in mining stocks, you may wish to consider first creating a large data set or spreadsheet, and then narrowing down from there.
3. Google Finance is a tool I've found very useful in researching stocks listed on US and Canadian exchanges. Just type the name of the company in and you can see their financial data. We'll discuss using their scanning tool to find companies later in this series.
Here are the terms noted in this video:
Market Capitalization -- the market value of the company; how much it would cost to buy up all the shares. I like to think of $1 billion to $2 billion as the "sweet spot" where stocks have proven themselves a bit and have some committment from other investors but still have great upside potential. Below $500 million are the very high reward/high risk plays, and above 20 billion are often the "blue chip" mining stocks that are very stable and yield dividends. Market capitalization gives us an instant risk profile of companies.
Current Ratio -- Current assets divided by current liabilities. This is a measure of how fiscally solvent the company is; a current ratio below one suggests a company that may have trouble sustaining operations. Especially for miners that are pre-production, ensuring they have enough capital to sustain operations is vital. For the really small companies with a market capitalization of $100 million or less, I like to see a current ratio of 8 and up.
Debt to Asset Ratio -- This is related to current ratio, but it accounts for long-term debt and illiquid assets as well. If a company has lots of long-term debt, that can be a problem if it needs to secure more credit in the future, and it can make unappealing as an acquisition target.
Price to Book Ratio -- Take market capitalization, and divide it by the Equity amount listed on the balance sheet and you get your price to book ratio. This is basically a measurement of how much the stock is trading relative to how much its assets (property rights, mining material, etc) are worth. I like to see price to book ratios of under 3 for companies with a market capitalization of over $1 billion. Sometimes, when there are big sell-offs, you can find price to book ratios of under 2 and sometimes even under 1 -- meaning the company is selling for below what it's assets are worth. Sometimes this is a signal as to there being a larger problem with the company, but it can often be a signal of mispricing as well if what caused the sell off was an extreme move driven by an irrational panic of some kind.
4. Lastly it is worth noting that being selective is very important for those looking to succeed in stock picking. The big winners are few and far between, and so using financial statement analysis to filter out stocks is a part of the game for many stock investors.
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