Even the best junior mining stocks are risky—so it’s important to take steps to minimize that risk.

A key part of our Successful investor approach is for investors to spread their stock portfolio out across most if not all of the five main economic sectors (Manufacturing & Industry, Resources & Commodities, the Consumer sector, Finance and Utilities).

After that, investors sometimes wonder if they should invest in junior mines as part of the Resources component. There can be room for the best junior mining stocks in that small part of your portfolio focused on aggressive investments. However, you need to be aware of the risks and to choose carefully.

Five ways to profit from the best junior mining stocks

Here are five main things we look for when analyzing stocks in the volatile junior-resource sector:

1. We want to see experienced management with a proven ability to develop and finance a mine.
2. We always look for well-financed junior mines with no immediate need to sell shares at low prices, since that would dilute existing investors’ interests. Even better, we like to see a major partner who can finance a mine to production.
3. We compare the market cap of the junior mines with the estimated value of their assets or future earnings stream. Some need to quickly find or develop a mine to justify the current share price and avoid collapse.
4. We avoid junior mines that trade at unsustainably high prices as a result of broker hype or investor mania.
5. We automatically rule out investing in juniors that promote themselves too aggressively, or do so misleadingly. Success is more likely if the managers focus on finding a mine, rather than hyping their story.

The best junior mining stocks will have solid reserves

When you invest in any resource stock, gold included, you need to look at how long the company’s reserves are likely to last. Those with low reserves need to have consistent success in their exploration programs to maximize the production of the mine and the surrounding area. That success is far from guaranteed.

The best junior mining stocks will not come from unstable locations

We generally stay away from mining stocks operating in insecure and politically unstable regions like the Congo and Venezuela, or in countries with little respect for property rights and the rule of law, like Russia or Mongolia. Mining is inherently a politically vulnerable business; you can’t move the mine to another country, and local citizens sometimes believe that a foreign mining company is robbing them of their birthright, even though they need the foreign company’s capital and expertise to get any value out of the ground.

Know the market cap of junior mines before investing in them

We always look at the market cap of junior mines versus the estimated value of the mineral resource they have in the ground. Sometimes, a company’s marketing efforts are so successful that they drive the stock up too high in relation to the size of its ore body. We like a mining stock’s market cap to be no more than half the value of the gold or other minerals in the ground. We assume that the company will be able to expand its ore reserves after the mine opens, but if the mineral reserves are double the mining stock’s market cap, it provides a margin of safety.

Build a diversified portfolio even if you want to invest in the best junior mining stocks

If you diversify as we advise, you improve your chances of making money over long periods, no matter what happens in the market.

For example, manufacturing stocks may suffer if raw material prices (including energy) rise, but in that case your Resources stocks (and potentially junior miners) will gain. Rising wages can put pressure on manufacturers, but your Consumer stocks should do better as workers spend more.

If borrowers can’t pay back their loans, your Finance stocks will suffer. But high default rates usually lead to lower interest rates, which push up the value of your Utilities stocks.

As part of their portfolio diversification strategy, most investors should have investments in most, if not all, of these five sectors. The proper proportions for you depend on your temperament and circumstances.

Established mining stocks can provide value to some investors. What characteristics of junior mining stocks have led to your buying of these stocks?

Junior mines can be a risky investment, but under the right circumstances they could pay off for careful investors. What traits in junior mines make you feel they are worth the investment risk?