Key Financial Ratios To Analyze the Mining Industry

The mining industry is one of the oldest established industrial operations. It continues to hold great interest for individual and institutional investors.

Key financial ratios used by investors to research companies in the mining industry are the quick ratio, operating profit margin, and return on equity.

Read on to learn about the mining industry and the ratios used to size up the financial health and profitability potential of mining companies of interest.

Mining Operations: Overview

Mining has been critical to the development of major countries, such as the U.S., Canada, and Australia. The entire western hemisphere, both North and South America, is rich in a wide variety of mining deposits.

Africa as well is rich in mineral deposits, notably gold and diamonds, and several of the major mining companies have had mining operations established there for decades. Australia is a notable source of gold and aluminum.

China is the world's richest source of rare earth minerals, containing an estimated 90% of these minerals that are important elements in the manufacture of automobiles and many other products.

The U.S. was at one time the world's leader in the production of many major mining products, but increasing environmental regulations have curtailed much of the U.S. mining industry. Russia is a leading country for mining enterprises in Europe.

The Mining Industry

The mining industry is subdivided into categories based on the principal mining interest. The three main subdivisions of the industry are precious metals and gemstones mining, industrial and base metal mining, and nonmetal mining, which includes mining for such important commodities as coal.

The industry is further divided into major mining companies, such as Rio Tinto PLC (RIO) and BHP Group Limited (BHP), and "junior miners." Junior miners are typically much smaller companies primarily engaged in the business of exploration or discovering new mining deposits.

Many junior mining companies that make major finds are eventually acquired by one of the major mining companies with extensive financial resources capable of funding large-scale mining operations.

Investing in Mining Companies

Mining requires extensive capital expenditures, both for exploration and the initial establishment of mining operations. However, once a mine is operational, its operating costs tend to decrease significantly and remain relatively stable.

Since mining revenues are subject to fluctuations in commodity prices, it is important for mine operators to manage changes in production levels wisely.

Key Financial Ratios

Quick Ratio

The quick ratio is a basic metric of liquidity and financial solvency. The ratio measures a company's ability to handle its current short-term financial obligations with liquid assets. These would be cash or assets that can quickly be converted into cash.

The quick ratio is calculated by dividing the total current assets minus inventory by the company's total short-term obligations.

This ratio is often referred to as the "acid test ratio" because it is considered such a strong fundamental indicator of a company's basic financial health or soundness.

It's considered important for evaluating mining companies because of the substantial capital expenditures and financing necessary for mining operations.

Analysts and creditors prefer to see quick ratio values higher than 1, the minimum acceptable value. As of Dec. 31, 2023, Rio Tinto had a quick ratio of 1.17. BHP Group had a quick ratio of 1.22.

Operating Profit Margin

The operating profit margin is a primary profitability ratio used by analysts to gauge how effectively a company manages costs.

This is important in the mining industry since mining companies frequently have to adjust production levels, significantly changing their total operational costs.

Operating margin is calculated by dividing total operating profit by total revenues. A company's operating profit margin is considered a strong indicator of its potential growth and revenue.

The average operating profit margin varies substantially between and within industries and is best used to compare very similar companies. For 2023, the mining companies Rio Tinto and BHP Group had operating profit margins of 29.12% and 43.75%, respectively.

Return on Equity

Return-on-equity (ROE) is important for investors because it indicates the level of profit a company can generate from equity and return to stockholders. The ratio is calculated by dividing net income by stockholders' equity.

As of January 2024, the ROE for the metals and mining sector was 12.17%. As of August 29, 2024, Rio Tinto and BHP Group had 12-month average ROEs of 19.81% and 37.47%, respectively.

Analysts sometimes factor out of the calculation preferred stock equity and preferred stock dividends, resulting in the return on common equity ratio (ROCE). A popular alternative metric to the ROE ratio is the return on assets (ROA).

The Bottom Line

Mining is an industry with a long history and is still firmly in the sights of investors, especially given the demand for the metals needed for current and developing technologies.

Some key financial ratios that investors and analysts use to determine the viability of mining companies as investments include the quick ratio, operating profit margin, and return on equity.