The resource sector, which includes energy and commodities, is a volatile place. The average standard deviation of the energy sector over the years is north of 20 percent, and commodities isn’t far behind at nearly 19 percent. This is far and above other sectors. And this year that level of volatility will totally eclipse the average. But with that volatility comes great opportunity and big risks.
It takes an extremely disciplined methodology to navigate it all, a methodology that is very similar to angel investing.
The facts are that many of the companies you’ll hear about are simply pieces of shit. They may be scams with totally fraudulent or incompetent management, with a high likelihood that they are misstating their assets, and practicing VooDoo accounting. There’s also the possibility that they are a good company but appear weak according to their peers, until you look under the hood. We want to uncover these companies because they can be great long term investments and deliver huge returns.
Like I said, this requires a disciplined approach, where we must do our due diligence. And to do that, we follow a process and a checklist…the AA Methodology. Here it is:
Reference check the People: There is nothing more valuable that character and reputation. Always look for the person or team that exudes the highest degree of these qualities. You want someone or some team that has serial successes, they are tight with the budget, and they come with impeccable references. Another good tell is whether the people have skin in the game. Read Nassim Taleb’s book by the same title “Skin in the Game: Hidden Asymmetries in Daily Life”
Validate the Project: This is a critical part of the due diligence as it is perhaps the most difficult to certify unless you either have boots on the ground or reliably and trustworthy people supplying accurate data. We need to validate the claims about the recourse that management is making. Of course you go a long way in the trust part of this equation by having good management, but even good people can become compromised.You need to know the following metrics:
- Quality of the resource
- How much of it there is in terms of extraction per time period
- What is the cost of extracting the resource
Business Financials: The process is a filter mechanism, so if the project does dot pass the first two steps, there’s really no reason to analyze the finances of the project. However if there is great management and an attractive resource worth pulling out of the ground, you want to know that the project is financially sustainable.
You need to find out and verify how much cash they have, what level of debt there is, who are the investors/financiers, do the managers have “skin in the game”. In general it’s a good sign when there are institutional investors involved as they have undoubtedly done their own due diligence. You also want to know if the company has issued warrants, which could potentially dilute the stock in the future. If we can get ahead of that and obtain warrants, then life is good.
Marketing Plan: This is all about the ability to drive the story to investors, to create enough buzz to drive money to the project when the time is right. Once we have established a position, we want great press to get the story out and attract lots of quality investors. This better the marketing plan, the more likely money will be attracted to the project, the higher share price is likely to go. Pretty simple.
Catalyst: We need to try and find potential catalysts that will shine a big fat light on this project. If there are more than one, that’s great, so long as at least one of them is significant and has a high degree of likelihood that it will jolt the industry, and make headlines.
Price to Value: Is the price right, what is the potential and are we getting in soon enough to see at least a 100 percent return. Is there a possibility of a 10X or even 100X return? In general you get what you pay for, and we don’t mind paying for value, but it’s the underlying potential of that value, and the growth prospects that are ultimately what is going to make our fortune. In general, we don’t want a fly-by-night or flash in the pan, we want a quality investment that will keep paying dividends, literally.
