Thoughts on mining (2017 edition)

Some key lessons on mining companies:

  1. They regularly withhold key information from investors.
  2. Technical reports should not be relied upon because many of them are disconnected with reality.

Without key information on a mine’s economics, these companies cannot be accurately valued.  So… mining stocks aren’t a great place to look for longs.  You might spent a lot of effort trying to value a mine and still fall short of being able to find reliable information on that mine.

On the short side, there are some opportunities.

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The Chipotle Mexican Grill way

(This is not an actionable idea or writeup.)

What makes Chipotle different is how small its menu is.  With a barebones menu, the restaurant can turn over its food quickly.  This allows Chipotle to make food before a customer orders, allowing customers get freshly-cooked food without having to wait for that food to cook.  This means high-quality food with a very short wait, making Chipotle an attractive choice for workers on their lunch break (or anybody who wants a quick meal).

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Scumbaggery matters, but only up to a point

When researching a stock, sometimes I stop caring about how shady the insiders might be.  The quality of a business usually overpowers insiders’ shadiness.  For example, Steve Madden (SHOO) is an example of terrible corporate governance.  It originally began as a ‘chop stock’ (similar in concept to a pump and dump).  Many of the people behind the scam went to jail or were barred from the securities industry.  Steven Madden, the founder of the company, went to jail.  But even after many people went to jail, the shenanigans continued.  While in jail, Steve Madden was paid a high six-figure salary even though he admits that he didn’t work while in jailDespite all of this… the stock did incredibly well since its IPO.  In many cases, the underlying business can make far more money than insiders end up stealing/siphoning/wasting.

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Quickly estimating the DCF of oil and gas reserves

From what I can tell, practically all stocks’ oil and gas reserves will have a Net Present Value of roughly 2-7 times the trailing twelve months’ cash flow.  One relevant article is titled: “The Valuation of Oil and Gas Properties: Are They Really Worth 3x Cash Flow?“.  For conventional wells, the 3X rule of thumb should come fairly close to the NPV in most cases.

I use this shortcut to get a quick sense of whether or not an E&P is massively overvalued.  Currently I only short E&Ps and am not seeing any undervalued E&Ps even though these stocks have fallen a lot.

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The shortcut method for figuring out a company’s accounting

Here’s what I do… I look at how the company handles depreciation and amortization of its assets.  If management is trying to inflate earnings, it is highly likely that management will be aggressive in making aggressive estimated useful life assumptions behind D&A.

  1. It’s really obvious to the accountants that they can inflate earnings by making more aggressive assumptions here.
  2. Pulling this lever is perfectly legal since these assumptions are inherently uncertain and therefore subjective.  No one will go to jail for pulling on this lever.
  3. All companies have to make assumptions on this accounting topic.

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Chart reading… the crazy short selling way (plus other silly tricks)

Here are some shortcuts that I use to quickly figure out a stock.

  1. Mysterious price spikes on high volume and little/no news.  Sometimes, these coincide with stock promotion like an email blast, physical mailers arriving, etc. etc.  A stock that has many of these spikes is probably an egregious pump and dump.
  2. The stock IPOed during the Dot-Com era and has been on a slow decline since.  Usually these Dot-Bomb wreckages are a decent place to look for shorts.  A lot of questionable stuff went public during the Dot-Com boom.  Such stocks have a tendency to stay somewhat questionable.  Pedigree matters.
  3. The share price performance since inception isn’t very good.  Usually a sign of a bad or mediocre underlying business.

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