If you hope to be successful investing in mining exploration companies, avoid speculative penny mines, unsustainably high trading prices, and unrealistic prospects

Every day a mine is in production, its assets are being depleted. That means the owners are always looking to replace those resources, often by buying other mines or companies. However, it’s not uncommon for mining companies to overpay for assets, especially in times of high commodity prices, or if there are few high-quality assets to purchase.

On the other hand, one of the best ways for these companies to build value is through exploration in the same area as their current mines or elsewhere. While sometimes risky, investing in mining exploration companies can lead to strong performers when commodity prices move up.

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Characteristics of the top mining exploration companies

We recommend looking for strong reserves, low production costs and mines that are already producing and generating cash flow when investing in mining exploration companies. Good mining company stocks have a range of development projects, but their strong base of production cuts the risk of relying on new developments alone.

When you invest in any mining stock, 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.

Even if the company has strong reserves, the best mining company stocks with the least risk also have a diversified reserve base. That way they are not dependent on a single mine’s production or political stability in any one country. Mining companies can also increase their reserves by making acquisitions—with some mineral prices down from their record highs, you may see an increase in mining company acquisitions, ideally at distressed prices.

How to minimize risk while investing in mining exploration companies

When we recommend mine stocks, we want to see positive cash flow, preferably even when commodity prices are low. Even better, we like to see mining companies that have cash flow from an existing mine that is sufficient to cover, or at least contribute to, the cost of developing a second mine.

We avoid mining stocks that trade at unsustainably high prices because of broker hype or investor mania. Instead, we focus on reasonably priced mining stocks with realistic prospects.

Avoid penny mines while investing in mining exploration companies

Penny mining stocks are some of the riskiest stocks Successful Investors can buy. These companies aim to find mineral deposits with mine-making potential—but such finds are exceedingly rare. Because of this, it’s even more important to try to maximize investment quality in penny mines.

For example, we automatically rule out investing in penny mines that promote themselves too aggressively or do so misleadingly. The mine-finding effort is more likely to succeed if the managers focus on finding a mine rather than hyping their stock.

Ultimately, penny mines should always be a very small part of any diversified Successful Investor portfolio. As well, you should only buy the most speculative of them with money you can afford to lose.

4 tips for successfully investing in mining exploration companies

Avoid buying mining stocks that trade at unsustainably high prices: This is usually due to broker hype or investor mania about the underlying commodity. Instead, we focus on reasonably priced mining stocks with favourable geology.

Invest in well-financed mines with sound balance sheets: We look for well-financed mining stocks with no immediate need to sell shares at low prices, since that would dilute existing investors’ interests. The best junior mines have a major partner who has agreed to pay for the drilling or other exploration or development, in exchange for an interest in the property. The best mining stocks all have sound balance sheets and low debt.

Look at future demand: For example, rare earth stocks could grow over the coming years. The world’s demand for high-end rechargeable batteries will likely increase, and the rare earth refinement process will also become less toxic. This opens up opportunities for mines in more environmentally strict jurisdictions.

Look at the market cap of mining stocks: We look at the market cap of mining stocks—including junior mining stocks—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 mine. We assume that the company will be able to expand its reserves after the mine opens, but if the reserves are double the mining stock’s market cap, it provides a margin of safety.

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What advice would you share with a new investor interested in mining stocks?