Commentary: Making mega profits from microcap stocks

Opportunities to make a fortune in stocks may occur only a few times during our lives. These opportunities tend to happen during periods of maximum investor pessimism when it takes a great deal of courage and foresight to be a proactive buyer. In my opinion, there is such an opportunity in microcap junior mining stocks today.

Last year, some of the most respected authorities on junior mining stocks were proclaiming that 30% to 50% of the TSX Venture Exchange-listed microcap resource companies would not survive the year. In that environment, it was challenging for most investors to ignore the “experts” and buy. However, the doomsayers were wrong. In fact, to date, only a fraction of these companies have disappeared. Many investors who bought during the denouement of the tax-loss season in December 2013, during the market lows, have subsequently outperformed the major indices.  Even so, opportunities remain as many stocks are still trading near their lows and pessimism is still near highs.

While numerous resource stocks were pounded into oblivion during tax-loss season in December 2013, the smallest companies (microcaps or nanocaps) suffered the greatest damage and today may offer the most significant returns to investors who understand the complexities of investing in this arena.

Investing in microcaps in today’s challenging environment is not for the inexperienced. Even the most astute investor may end up with some stocks that become total writeoffs. In order to reduce risk, it may be prudent for investors to diversify and buy a basket of microcaps from several mineral sectors. Some investors may decide to hold their microcaps within their TFSAs (tax-free savings accounts) in order to avoid taxes in anticipation of tremendous gains. In that case, those investors must forego deducting any capital losses from their losers. Each investor must consider their personal tax situation and risk tolerance before proceeding.

For those who feel they are able to tolerate the risk and volatility, the next step is to perform some careful due diligence to determine which stocks to buy. There are a few basic considerations for selecting microcaps in the current climate. These criteria are:

1)      Project appeal                                                

2)      Share consolidation risk                                          

3)      Management

The foremost consideration when selecting a microcap should be the potential of the project as well as its investor appeal in order to attract future buying interest in the stock at higher prices. Investors must assess the project in order to determine if it distinguishes itself against its peers both in potential and uniqueness. If the target mineral is out of favour with investors, then the company may face challenges in raising capital or the stock may not react on exploration news. If the potential size of the project is small, then the stock may not attract larger investors even when positive results are released. Investors should focus on those companies whose stories can make other investors get excited about buying the stock when they hear about it.

One of the greatest challenges investors in microcaps face today is the possibility of a share consolidation. When share prices drop below the stock exchange’s minimum financing threshold of 5¢, companies may not be able to raise capital. In order to finance, the management must then consolidate the shares to enable the share price to rise to or above the 5¢ threshold. Depending on the terms of the financing, this consolidation may destroy potential profits as it can be highly dilutive to existing shareholders.

When investing in stocks below 5¢, investors should consider the possibility of a share consolidation and how it may affect the share price afterward. Investors should start by reading the most recent proxy available on www.sedar.com to check if the company has already proposed a share consolidation to its shareholders. Also, investors should examine the company’s balance sheet to estimate whether the company currently has enough cash for an exploration program. If it does, then there is a possibility that the exploration results could boost the stock price above 5¢  and a share consolidation may not be necessary. If there is very little money in the treasury and the stock is well below 5¢, then the probability of a share consolidation is higher. In that case it may be more prudent to wait until after the share consolidation has taken place and the terms of a financing are announced.

Finally, investors in microcaps must rely on management to guide the company through the series of never ending challenges they will face. Ideally it is best to focus on those companies whose management have had prior experience and who are well connected in the investment community. Connections often play a critical role in raising capital. Look for management that holds a large vested interest in the stock and who have stock options priced well above the current market. They will be more likely to do whatever is necessary to avoid a share consolidation to protect their own investment. Investors can find the number of shares management own and the price of their options by reading the Management Information Circular and Audited Annual Financial Statements on www.sedar.com.

EIGHT MICROCAPS WITH EXPLOSIVE POTENTIAL

COMPANY	DETAILS
GPM Metals TSXV: GPM Stock price: 8¢ Market Cap: $9M Focus: zinc, lead	–4¢ per share in cash (50% of market cap) reduced risk -the Walker Gossan property is one of the most exciting zinc/lead deposits in Australia -requires aboriginal approval to explore Walker Gossan, which make take two years or may never be granted -management is highly competent in junior mining -low probability of share consolidation
Metals Creek Resources TSXV: MEK Stock price: 4¢ Market Cap: $4M Focus: graphite, gold	-2¢ per share in cash for exploration -joint venture with Goldcorp on Ogden (Timmins) gold property has shown encouraging results -currently focused on exploring Feagan Lake graphite property near Zenyatta graphite discovery -low probability of share consolidation
Arrowhead Gold TSXV: AWH Stock price 9¢ Market Cap: $2M Focus: gold, marijuana?	-investigating “agricultural, pharmaceutical, medical technologies,” implying the company may enter the popular medical marijuana sector -management has no experience in the growing of medical marijuana and insufficient capital to do so -for nimble traders only as the company may fail in its attempt to enter medical marijuana space -recently underwent a 4:1 share consolidation
Honey Badger Exploration TSXV: TUF Stock price: 3¢ Market Cap: $2M Focus: cobalt, copper, gold	-potential “Olympic Dam” style iron oxide copper-gold deposit in Quebec: Sagar property may become one of the more exciting exploration programs in Canada -cobalt showing could excite investors seeking exposure to electric vehicle investments because battery makers such as Tesla use cobalt in cathodes -faces challenge of raising $3-4 million in cash in the short term to complete acquisition of property -low probability of share consolidation
Pure Nickel TSXV: NIC Stock price: 3¢ Market Cap: $2M Focus: nickel, gold	-seeking partner for MAN nickel project in Alaska -4 cents per share in cash (130% of market cap) provides a source of funds for a small exploration program -may explore Salt Chuck gold deposit prior to MAN -low probability of a share consolidation
Aldershot Resources TSXV: ALZ Stock price: 1¢ Market Cap: $1M Focus: uranium, vanadium	-two uranium/vanadium deposits in the U.S. are NI 43-101 compliant with valuations greatly exceeding market cap -company requires working capital to advance projects -high probability of share consolidation of at least 10:1
Ditem Explorations TSXV: DIT Stock price: 1¢ Market Cap: $1M Focus: gold, other	-actively seeking projects of merit but has no working capital – acquiring a project of merit could excite the stock as the company has a large following by Quebec investors – high probability of share consolidation of at least 10:1
Entourage Metals TSXV: EMT Stock price: 2¢ Market Cap: $1M Focus: gold	– raising capital for gold exploration in Ontario and Yukon will be challenging unless current market environment changes – preliminary exploration results are encouraging – the company has no working capital and will most likely be forced to issue more shares in the coming months – a 6:1 share consolidation has already been announced

The table above illustrates a portfolio of eight microcap resource stocks with significant potential. However, most likely there are many more to chose from. Investors should be reminded that investing in small resource stocks demands a great deal of patience and time. As always, investors should consult a professional investment advisor to see if investing in speculative securities is appropriate for them.

— Peter Besler is an investment advisor with Industrial Alliance Securities in Toronto. The author may own or trade in the securities listed herein. He can be reached at (416) 594-2257, or pbesler@mgisecurities.com. This article originally appeared on The Northern Miner’s sister website, www.miningmarkets.ca .