when the gold mine opens…

…the company’s stock falls apart.

a Wall Street parable:

A group of geologists forms a gold mining company and raises money from investment managers at $8 a share.  It goes public a few months later at $10 a share, having bought a bunch of mineral rights with the initial seed money.

Shortly thereafter, the company announces it has identified a potentially attractive ore body on one of its leases and has begun drilling to confirm the presence of gold ore and the extent of the find.  The stock rises to $15.

The company announces that has found gold.  Rumors begin to circulate that the ore body is much bigger than expected.  The company is sending ore samples to a laboratory for analysis.  The stock goes up to $20.

It turns out the ore samples are richer in gold content than initially thought.  Rumors circulate that the ore contains significant byproduct amounts of silver and other metals–which would imply that mining costs will be unusually low.  The stock reaches $30.

The company begins to build a processing plant and says production will commence in six months.  The stock rises to $40.

 

During this entire period, very little hard and fast information is available.  Analysts fill the void with bullish speculation about the extent of the find, the high purity of the ore grade and the possibility of very high byproduct credits.  Their spreadsheets show “best case” profits rising to the moon as each analyst tries to out-bullish his rivals.

Then the mine opens.

There are initial teething problems with the mine, so production is low.  The ore grade is high, but less rich than analysts’ speculations would have had it.  Byproduct credits are not as great as analysts had typed into their spreadsheets.

The stock falls to $20, as actual data puncture the speculative balloon Wall Street had inflated.  Where the stock goes from there depends entirely on how the numbers pan out.

relevance?

This is an extreme example of investors letting their imaginations run away with themselves in advance of, and in the absence of, real operating data.

It happens more often than Wall Street would like to admit.   Euro Disney is a perfect example of this phenomenon in action in the non-mining arena.  The stock peaked just as the park opened and the turnstiles started recording actual visitors.  (Note:  if you check out a Euro Disney chart, remember that the stock had a 1-for-100 reverse split in 2007, which the online charts I’ve checked don’t adjust for.  So that 3.4 euro price is really 3.4 euro cents!)

To some degree, every growth stock eventually gets overhyped and reaches an unsustainably high price-earnings multiple.  Normally, the inevitable multiple contraction begins as investors sense the company’s growth rate is slowing.  But sometimes–as in the case of AAPL–it happens earlier.  In the fictional case above, the overvaluation happens right out of the box.  This is also what the 1999 Internet stock boom was all about.

In today’s world, I think Amazon (AMZN) could be another potential case in point.    …attractive concept, lots of whispers, little hard data, a multiple that–even adjusting the company’s (conservative) accounting to make the financials look more comparable to other publicly traded companies–looks very high to me.

Among the “big data’ recent listings, more 21st-century gold mines may also be lurking.

Caveat emptor, as they say.

 

 

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