Think about some of the stocks you own and/or are itching to buy. Now, consider the following critera/scenarios and notice how your picks will decrease (narrow)…

What shares of companies would you buy/own if…

  • You had to hold the shares for 3 years?
  • You had to hold the shares for 5 years?
  • You were aiming for a probable 30%-50% return in 12-18 months?
  • You would only accept a 30% correction?
  • You would not accept real risk of total loss within 3 years?
  • You only invest in companies with a real shot of delivering free cash flow within 3 years?
  • You would theoretically have to buy the whole company instead of a small %?

(Do yourself a favor and really consider the criteria above and reflect on what stocks you perhaps should buy more of or sell etc)

… I really doubt that any, or at least few, of the criteria mentioned above are front and center in the minds of most investors (speculators). We often _feel_ like the only way to get “rich” is to find the stocks that will make us rich no sooner than tomorrow. This is also why most pure exploration stocks are grossly overvalued compared to developers in my opinion. The funny (ironic) thing is that I would argue that it is exponentially easier to find stocks that have a probable upside of 30%-50% within 12 months compared to finding a stocks that have a 20% chance of appreciating 100% within the next month for example. Furthermore, if one would be able to stick to the former, and rinse and repeat every 12 months, then becoming wealthy has gone from “if” to “when”. I believe that kind of mentality would also lead people to automatically look for depressed stocks (aka “bargains”) with some degree of margin of safety while automatically finding it hard to justify buying the “hot” and probably overvalued stock.

If you started out with $10,000, deposited an extra $5,000 per year and averaged a return on investment of 30% per year, your portfolio would be worth $96,000 in five years and $415,000 in 10 years… And the returns just get crazier with every passing year from that.

The heart of the matter is that an annual return of 30% is truly superb and aiming much higher often leads people to take on much more risks and make unnecessary mistakes.

Warren Buffet: “Rule number one, don’t lose money… Rule number two, see rule number one”

When considering “the 8th wonder of the world”, compounding, the most important thing becomes limiting the downside (margin of safety). It boils down to one simple truth which is that you can’t compound what you don’t have.  This point makes _permanent_ loss of capital extremely detrimental. Volatility and share price corrections are unavoidable and thankfully not disastrous as long as the fundamentals of a company haven’t gotten considerably worse (thus increasing the chance of permanent loss). On that note, even one of the most famous long term growth companies in the form of P&G have seen three 25%-40% corrections since the financial crisis. In that case, the worst MISTAKE for a long term investor would be to SELL when the share price already had gone off a cliff.

Volatility does not equal risk and share price does not equal due diligence.

Volatility of the market is supposed to be taken advantage of, not to be used as a due diligence tool. Daily fluctuations is mostly noise and has nothing to do with the intrinsic value of any particular company. I personally believe that people would be better investors if one just assumed that the market was completely clueless and one did ones own due diligence before even looking at share price and valuation.

Furthermore, consider how cheap success is trading for. Seriously, pick any developer with a tier 2 project or better and compare it to some of the hot exploration plays. Oftentimes the value discrepancy would indicate that most hot exploration stocks have a 20% chance or better of  finding a tier 2 deposit, which is pretty insane. Then add on the fact that it will take a lot of dilution and years of continued success to even reach the stage of the developers. If we are talking the time to reach cash flow and become an actual “business” then add on 5-10 years to boot.

My main point of this article is to point out a few things:

  1. It’s much easier to actually get rich by lowering ones expectations
  2. Averaging say 30% per year WILL make you rich faster than you realize
  3. Aiming to get rich TOMORROW has a very low probability of success and the rich part becomes and “if” instead of a “when”
  4. Focus on the downside and the upside will usually take care of itself
  5. Look beyond the short term since that horizon is probably crowded and overvalued because of it

An example of point 4:

Lets say you find company that has a) got cash in the bank, b) has got good people involved and c) is trading at a 90% discount to value on paper…

What risks are we taking on?

Black Swans? Sure, that holds for any stock.

Could it get cheaper? Sure, the market can do anything.

… But the path of least resistance ought to be up, towards “fair value”.

Even if the project is worth 50% of face value, the company will still be cheap. If you buy something that is priced at 100% of face value, that clearly opens an investor up to a broader range of potential negative surprises when theory meets reality. A lot can go wrong with a cheap stock, and it should not affect the value of the company anywhere near as much as a negative surprise for a “fairly” valued company. If most risks one could think of is already reflected in the valuation of a company, how much risk are you as an investor actually exposed to?

Lastly, some personal examples:

(Note: The three companies below are sponsors of mine and I own shares in all. These are NOT buying recommendations!!!)

Novo

  • Consensus is that almost nothing will work, so what negative surprises going forward would materially affect the SP  in a negative way?
  • Beaton’s Creek is pretty much written off even though I think that positive news on that front could underpin most of the current valaution
  • Ore sorting news nor Egina news made any real dent in the valuation so am I not paying for the potential upside as an investor?
  • Got money and lots of exploration and de-risking potential  to further increase intrinsic value over the coming years

Lion One Metals

  • Huge system but it’s still trading at about a 50% discount to their starter project
  • What material downside risks am I exposed to in this case? Will the project all of a sudden go up in smoke?
  • How much upside potential do I get for free?
  • Got money and lots of exploration potential to further increase intrinsic value over the coming years

TriStar Gold

  • TriStar’s market cap is trading at a 92% discount to project NPV (at $1,500 gold)
  • How much worse would the project have to get for it to become expensive?
  • How much upside potential do I get for free?
  • Shares of the company can only go to zero, but it can also be a multi bagger just to reach “fair value”
  • Got money and lots of exploration and de-risking potential  to further increase intrinsic value over the coming years

… The above notes were just off the top of my head but I think you get the idea. Taking advantage of a market that prices securities low for whatever reason limits ones downside while at the same time magnifying ones upside. Compare that to a hot drill play which often got nothing banked and also often pricing in an unreal expectation of finding a tier 2 deposit or better. This is why I own few pure exploration stocks and most of them are very small positions.

(Note: This is not a buy or sell recommendation. This is not investment advice and I am not a geologist. This article is highly speculative and I can’t guarantee accuracy. I can’t guarantee the accuracy of the content in this article. Always do your own due diligence. I own shares of Novo Resources, Lion One Metals and TriStar Gold which I have bought in the open market and am thus biased. Novo, Lion One Metals and TriStar Gold are banner sponsors. )

Best regards,

The Hedgeless Horseman

 

 

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