From October 2002 to today, the price of gold climbed 442%. That works out to an average annualized gain of 18.4%.
Meanwhile, shareholders of giant gold producer Goldcorp gained just 338%... or an average annualized gain of 15.9%.
This weak performance from Goldcorp – considered one of the top gold companies on earth – surprised a lot of mining investors. After all, gold producers are supposed to be "leveraged" to the price of gold. They are supposed to rise more than the gold price.
Goldcorp has disappointed investors... What happened?
At last week's S&A Alliance conference, my friend Morgan Poliquin told the audience why this was the case...
Morgan is the president and CEO of junior mining company Almaden Minerals. And he's a lifelong veteran of the gold industry.
He grew up as a field hand for his father, who founded Almaden in 1986. I've known them both for several years now... and speak to them often about companies, projects, history, geology, and engineering in the gold sector. The Poliquins are true insiders in the gold-mining community.
So how could Morgan say it's possible that a major gold miner could be outperformed by the commodity it was producing? It made no sense... until you looked at the number of shares Goldcorp issued over that 10-year period.
You see, Goldcorp's management wanted to grow rapidly. That meant buying out other companies, rather than taking the slow, organic route. To raise the cash needed to grow, it had two choices: borrow it or sell shares for it. Goldcorp chose to sell shares, which causes dilution.
Dilution is a term for what happens to your investment as the company creates new shares. Remember... a share is simply a slice of the company's value. If you cut lots more slices, the value of each one gets smaller. And that is bad news for investors. It is something we must watch out for, especially among junior miners.
Dilution severely reduces our return on investment. To see how it works, let's look at the Goldcorp example...
In October 2002, Goldcorp had just 182.2 million shares outstanding, a share price of $9.99, and a market value of $1.8 billion. But the company needed to raise more money. So from 2005 to 2012, it issued another 628.4 million shares.
That's almost 3.5 times as many shares as it had out in 2005. In other words, your original share lost 71% of its value through dilution.
Investors still made money in Goldcorp over that period... just not as much as they should have. The share price is now $43, so you made 338% over 10 years. As we discussed earlier, that's an annualized gain of about 15.9%. Not too bad.
But consider this... The company's market value actually grew 1,869%, or 34.7% per year, over that period. That's more than twice the annualized return... and that's how dilution stole from your investment.
In other words, the company sacrificed your investment to grow. And Goldcorp's stock underperformed gold bullion... with a whole lot more risk.
Dilution is an ongoing concern in mining companies. We must be aware of stock issuances and financings at all times. And dilution will suck profits right out of our accounts.
If Goldcorp hadn't grown its business, your original $9.99 per share investment would be worth just $2.20 today. That's a 78% loss. And that's a far more likely result than success.
However, not all mining companies grow the same way. For example, while Goldcorp's share count rose 345% over the last decade, gold miners like Barrick and Newmont only increased their shares by 41% and 85%, respectively.
It's critical to do this kind of homework before you make a big, long-term investment in the junior resource sector. Dilution will steal from your investments if you aren't paying attention.