The Unanswered Questions: Rick Rule on Talking to CompaniesAs most investors know, the markets are inherently cyclical and volatile. When they hit the bottom, it’s difficult to remind ourselves that what goes down must come up — particularly when we have to wait so long to finally see the light at the end of the tunnel.

While bear markets are an intrinsic part of the investing beast, investors should not get overly discouraged by the constant red on the charts. Instead, they should view bear markets as an opportunity to potentially find good deals and make money.

At the 2014 Canadian Investor Conference, held this week in Vancouver, Rick Rule, chairman of Sprott US Holdings, explained it best: ”the adage ‘buy low and sell high’ presupposes that you bought low, which is a difficult thing to do if you have been through a market like this.”

With the intention of helping investors better assess which companies will provide them with the best returns, Rule shared his strategy on talking to companies.

Rule’s thesis revolves around answering the “most important unanswered question,” which no doubt sounds terribly complicated. However, given that exploration is really just another form of research and development, answering the hard questions is absolutely key to determining which companies will add the most value to your investment portfolio.

The pitch

The first — and most unavoidable — step in this process is listening to the pitch.

Rule explained that while most people roll their eyes at the standard pitch — which company representatives churn out like an old record — listening to the pitch can be very important.

First off, the pitch can help investors understand key indicators about the company, as well as show whether the person doing the pitching is truthful.

“If the person presenting to you is a liar,” Rule explained, “then you know that you can never get information, and without that information you can never make a decision.”

With that determination, the line of questioning stops, and investors can move on.

The second way the pitch can be helpful is that it can show investors where the company is coming from.

It is key that a company believes in its end product. If company leaders are banking on someone else’s theories, Rule asked, why should investors should believe in the company?

As Rule explained, incongruities in the story are very important.

Refining the question

If upon initial inspection a company passes the pitch test, so to speak, then the next step is to assess what could add the most value in the next 12 to 18 months.

Unfortunately, the answer to that question is often not the same for companies and investors, even though it should be. Rule explained that companies usually have to ask themselves, “how do I make enough money to pay rent and my salary for the next 18 months?” For investors, that is absolutely irrelevant.

Instead, investors are focused on returns, returns, returns. On that note, Rule listed six points for consideration when assessing any company:

  • Scale: According to Rule, scale can be important either in terms of leverage on the commodity price, or in the context of making a deposit much, much bigger.”If you are taking the risks inherent to the business, you need to understand that most of your exploration decisions are going to end in failure … you need to make so much money on your successes that they amortize your failures and leave enough room for an acceptable margin.”
  • Probablility: In other words, what are the chances that this dream is going to come true? Overall the chances of success are slim; however, the current market lends itself to higher chances of finding a good play as there is not much competition.
  • People: Management teams are an incredibly important part of a company. As such, it is very important that management’s skills are best suited to the task at hand. Just because an executive has a proven track record in one type of mining does not necessarily mean that they will be successful in a completely different type.
  • Time: Rule said investors should look at how long will it take to understand if the company has a plan and how long it will take to be profitable. That can be an indicator of how long to hold a stock.
  • Means: Money is the name of the game — what will the project cost and how is the company getting the funds? Investors can and should follow up on where they are being told financing is coming from.
  • What is the flaw: Exploration costs money. That is no secret. The important question here is how and when a company will decide that a project is not viable and consider exploring another avenue to save investors’ money.

Rule also highlighted the unique opportunity that Vancouverites have over other speculative investors. The majority of resource companies are headquartered in Vancouver, which means that investors there really have no excuse for not doing their own due diligence and adding a digit to their portfolio.

Stay tuned for a video interview with Rick Rule.