A major challenge for all investors is deciding whether an opportunity is favourable or not. Certainly, a company can have huge potential; it may be operating in a fast-growing market, have a sound strategy and have the prospect of significant profits in the long run. However, the short to medium term can also include a number of hurdles that make its risk/reward ratio seem more difficult to assess, such as financing and the results of various programmes that are impossible to accurately predict.
In fact, it could be argued that this is the scenario facing investors contemplating the purchase of Rare Earth Minerals (LSE: REM). It has huge long term potential and recently increased the estimated reserves at its main Sonora lithium project in Mexico, which could lead to superb profitability in the long run – especially if demand for lithium continues to grow at a rapid rate.
However, Rare Earth Minerals currently has no revenue and, as the company pointed out in its recent update, the estimated reserves have yet to be proven as commercially viable. Furthermore, the process of turning the project from a potential mine to a producing mine is likely to be expensive, and there is no guarantee that financing for it will be easily available.
As such, Rare Earth Minerals has significant long term potential, but there are shorter term risks for investors to contend with, too.
Sector Peers
That’s a key reason why many investors may wish to favour larger peers such as Anglo American (LSE: AAL) and Fresnillo (LSE: FRES). Certainly, they may not offer the same level of long term rewards as Rare Earth Minerals, but their risks may be lower in the short term and this appears to make them more favourable buys at the present time.
And, looking ahead, both companies are expected to deliver impressive earnings growth. For example, Anglo American is forecast to post net profit growth of 32% next year, while Fresnillo is due to see its bottom line surge by a whopping 78%.
Of course, both of these growth rates may prove to be somewhat optimistic – especially since the commodity markets are relatively volatile at the present time. However, both companies appear to offer a very appealing margin of safety with, for example, Anglo American having a price to earnings growth (PEG) ratio of 0.4, while Fresnillo’s PEG ratio is even lower at just 0.3. As such, both stocks appear to offer growth at a very reasonable price – even if their forecasts are reduced over the medium term.
Furthermore, Anglo American and Fresnillo offer greater stability and financial strength than Rare Earth Minerals. This further reduces the risks involved in investing in them and, with Anglo American having been profitable in four of the last five years and Fresnillo delivering a black bottom line throughout the period, their track records should provide their investors with a degree of confidence regarding their prospects over the medium to long term.
So, while Rare Earth Minerals does have significant potential rewards, its risk/reward ratio does not appear to be quite as favourable as those of Anglo American or Fresnillo. As a result, the latter two companies seem to be the ones to buy right now.
