One of the simple joys in investing is finding a company that has the potential to grow well in the near term and produce a good return. It may take time to realise the gain, but cheap stocks, like seeds, need time to bloom.
We see it as cheap now because the market has mispriced it. We are focusing on the company and the traders are focused on the price. Even during bear markets, a company may be carrying on with its business, yet the price could be beaten down by gloom, fear or apathy.
That is the edge you have. You still have to find out about the company and why it will make progress.
Gold and copper producer Medusa Mining Limited (ASX: MML) has been on a general downward trend in share price since 2011. It hit a low in July 2013 of around $1.50 a share. Now it's about $2.
Since 2009 net profit margins have been high, usually more than 50%. In 2012, revenue dropped off, creating a lower profit, but the high profit margin still held up. In 2013, total annual revenue recovered somewhat.
In the first half of 2014, gold production was down due to maintenance issues. Lower gold prices also lowered revenues, yet on $34 million in revenue it still made a $13 million net profit, or a 38% net profit margin. I would watch this company's return to regular production and monitor further production expansion for potential gains in NPAT.
Rio Tinto Limited (ASX: RIO) had much lower earnings from its energy division in FY2013 than the year before. This contains its coal production. The aluminium division was down in FY2012 and was recovering in FY2013.
The bright spot was its iron ore production, where it was increasing its production capacity. Iron ore makes up about 48% of total group revenue. Overall, the company's underlying net profit margin was about 24% despite the setbacks. When it reaches its goal of 360 million tonnes of annual production capacity, earnings should move forward.
Foolish takeaway
I would consider both these companies cheap in comparison to what they could produce and achieve in the future. As iron ore expands for Rio Tinto, the proportion of coal's earnings contribution is lessened. It can move forward.
Medusa Mining had a temporary production setback. As that is cleared up, its earnings potential may improve and the share price may rise from its low level.
