Analyze key financial ratios in the mining industry

The mining industry is one of the oldest industrial operations. Mining is vital to the development of major countries such as the United States, Canada, and Australia. The entire western hemisphere, including North and South America, is rich in mineral deposits.

So far, Russia is the leading country for European mining companies. Africa has rich mineral deposits, especially gold and diamonds, where several major mining companies have established mining operations for decades. Australia is an important source of gold and aluminum.

China is the richest source of rare earth minerals in the world, and about 90% of rare earth minerals are important elements for the manufacture of automobiles and many other products.

The United States was once a world leader in the production of many major mining products, but increasing environmental regulations have restricted the development of the U.S. mining industry.

Key points

  • The mining industry is one of the oldest businesses in the industrial sector, with operations in China, Africa, Australia and other countries.
  • The three main categories of the mining industry are precious metals and gems, industrial and base metal mining, and non-metallic mining.
  • There are large mining companies and junior miners in the mining industry, which are small companies engaged in exploration.
  • Investors and analysts use a variety of financial ratios to measure the company’s profitability and the ability to manage costs, such as quick ratio, operating margin, and return on equity (ROE).

mining industry

The mining industry is subdivided into multiple categories based on major mining interests. The three main segments of the industry are precious metal and gem mining, industrial and base metal mining, and non-metallic mining, including the mining of important commodities such as coal.

The industry is further divided into major mining companies, such as Rio Tinto Group (RIO) and BHP Billiton Limited (BHP), and “junior miners”. Junior miners are usually smaller companies, mainly engaged in the business of exploring or discovering new deposits.

Many junior mining companies with major discoveries were eventually acquired by a large mining company with abundant financial resources, which was able to fund large-scale mining operations.

Investment in mining companies

Mining requires a large amount of capital expenditure, including the initial establishment of exploration and mining operations. However, once the mine is put into operation, its operating costs tend to be significantly reduced and relatively stable.

Since mining revenue is affected by commodity price fluctuations, it is important for mine operators to manage changes in production levels wisely.

Quick ratio

Quick ratio is a basic indicator of liquidity and financial solvency. This ratio measures the company’s ability to use current assets (cash or assets that can be quickly converted into cash) to handle its current short-term financial obligations.

The quick ratio is calculated by dividing total current assets minus inventory by the company’s total short-term debt. This ratio is often referred to as the “acid test ratio” because it is considered a strong basic indicator of a company’s basic financial health or soundness.

Since mining operations require large capital expenditures and financing, quick ratios are important for evaluating mining companies. Analysts and creditors prefer to see a quick ratio value higher than 1, which is the lowest acceptable value.

Operating profit margin

Operating profit margin is the main profit ratio checked by analysts and is used to measure the effectiveness of the company’s management costs. This is important in the mining industry because mining companies often need to adjust their production levels, which can significantly change their total operating costs.

The operating profit margin is calculated by dividing total operating profit by total revenue. A company’s operating profit margin is considered a powerful indicator of its potential growth and revenue. The average operating profit margins vary greatly between and within industries, and are most suitable for comparisons between very similar companies.

Return on equity (ROE)

Return on equity (ROE) is a key financial indicator considered by investors because it indicates the level of profit a company can generate from equity and the return to shareholders.

The average ROE of the mining industry is between 5% and 9%, and the ROE of the best performing companies is close to 15% or higher. This ratio is calculated by dividing net income by shareholders’ equity.

Analysts sometimes consider preferred stock equity and preferred stock dividend calculations to arrive at the return on common stock (ROCE). A popular alternative indicator of the ROE ratio is the return on assets (ROA).

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