(By Street Authority) In most instances, it pays to focus your investment research on companies that are delivering great results. Rising profits, thanks to market share gains, hot new products, international expansion and other factors often lead to a surging valuation for a company.
Yet for some types of stocks, this logic gets turned on its head. It's more important to see how a stock will be valued when business conditions are not quite so favorable. If the income statement takes a turn for the worse, then a large contingent of investors will likely head for the exits, revealing the price level in which more far-sighted investors spot deep value.
This has been my thinking since I have had a chance to digest the quarterly results of copper and gold miner Freeport McMoran (NYSE: FCX). A host of factors has just led year-over-year profits to fall sharply, and it's increasingly clear that investors are misreading many of the fundamental factors that should drive the company's results -- and valuations -- in the quarters and years to come.
It's why I can't resist the opportunity to add this global mining powerhouse to my $100,000 Real-Money Portfolio, as it possesses the two key characteristics I look for: robust potential upside and solid downside protection.
Focus on the assets for now
I have actually written about Freeport McMoran twice recently. First, I noted how investors had been selling the stock as profits slumped, missing the fact that the company's copper and gold mines are actually worth much more than the current stock market value would suggest.
Unfortunately, you won't find this value on the company's balance sheet. Indeed the company's $36 billion market value is well higher than its $16 billion in shareholder's equity. But this figure is quite misleading. It represents what Freeport McMoran has paid for various mines in the past – not what those mines are worth today.
Thankfully, we can grasp what mines are really worth. They are bought and sold every year, and we have a clear read on what companies pay to acquire various mines. This is where the work of Wall Street analysts can come in handy. Analysts who follow Freeport McMoran continually track the global mining industry and then seek to adjust the relative value of every company's mining assets -- if they were valued in line with recent deal trends.
For example, as I noted last week, Goldman Sachs says Freeport McMoran would be worth $50 a share if investors used current industry transaction trends as a benchmark. Of course, this assumes that a potential buyer would look to acquire the company at value accorded to other mining firms that have recently sold off assets.
This seeming undervaluation was one of the reasons why industry chatter suggested potential buyers were circling overhead, which I discussed here. I cautioned that many rumored deals never come to pass, and in the face of such chatter, Freeport McMoran's CEO Richard Adkerson went on CNBC this week to try to cool down the buzz, noting the company wasn't for sale.
But then he inadvertently expressed the precise reason I really appreciate this stock. "Natural resources are short. Companies in our industry have strong balance sheets and strong cash flows.