Ask Colin

You teach how to find value stocks. However, this only applies to industrials. How do you find resource value stocks?

The reason the low PE ratio, Low Dividend Yield approach works as a measure of value for industrial stocks is because of a basic assumption that the earnings of an industrial company are maintainable. Therefore prior year's earnings can be an indication of future earnings potential.

However, most resource companies are quite different. While a very few may have such a long-term resource that it will go on indefinitely, most are exploiting a wasting asset. This means that prior earnings can not be used reliably as an indicator of maintainable earnings. Instead one should use some kind of discounted cash flow model that reflects the wasting of the asset.

Another factor is that most mining companies are wide open to currency fluctuations and big price swings for their output, which are determined on a world market. Yes, there are exceptions, but the general picture is for a far more volatile revenue, and therefore earnings, outlook than for industrial companies. This makes the use of historical PE ratios as a guide to value far more hazardous.

There is therefore no easy way to scan resources companies for value. I tend to look for them the same way I look for growth model industrial companies, using the charts to find them. I find that with growth companies and resource companies, the chart is your best guide, because trying to estimate their earnings is so difficult and unreliable, even for the experts.