When considering any stock for your portfolio, don't be swayed by just the positives. Examine its pros and cons, and decide whether it's possible upside outweighs its risks. Let's take a look at Molycorp
Based in Colorado and with a market capitalization recently near $1.25 billion, Molycorp is a small producer and seller of rare-earth oxides, metals, alloys, and magnets used in clean energy technologies, defense applications, water treatment technology, and multiple high-tech uses. Over the past year, its stock has plunged about 78%, leading some to steer clear and others to wonder whether it may be a bargain now.
One reason to consider buying the stock is this: It has fallen sharply and over the long run, there will be ongoing demand for rare earth minerals. Molycorp's valuation seems attractive. Its price-to-earnings ratio was around 10 in 2011, well below the S&P 500's 15. Its forward P/E of 5 is less than half of the S&P 500's 14, and its five-year expected PEG ratio is 0.35, suggesting it's very undervalued. (Its price-to-sales and price-to-cash-flow ratios are considerably higher than those of the overall market, though.)
The company sports some attractive growth rates, with revenue exploding recently, from $35 million in 2010 to $397 million in 2011 and $460 million over the past 12 months. Earnings per share went from being in the red to being solidly in the black in 2011, though over the past 12 months, it has fallen sharply.
Here's another reason to consider buying Molycorp -- though it could be a reason to sell, too: It's heavily shorted, with close to a third of its float sold short as of mid-July. That means a heck of a lot of investors are betting against it. They might be right, but if they're wrong and the stock starts a steep ascent, they'll eventually have to cover their positions by buying shares, which will send the share price up on the "short squeeze."
One reason to consider selling Molycorp is the main reason that its stock has fallen so hard: The prices of rare earth minerals, which were rather high not so long ago, plunged, taking Molycorp and peers such as Rare Earth Resources
Then there's the ongoing dilution of its shares. The number of shares outstanding has gone from about 39 million in 2009 to roughly 100 million recently. Imagine a pizza being cut into more and more pieces -- your allotted slices will become smaller and smaller. Similarly, Molycorp shares will each have a smaller and smaller claim on the business.
By selling more shares, the company has generated more cash, some of which it has used to buy downstream businesses such as Canadian rare earth processor Neo Material Technologies, for $1.3 billion. In order to pay for the purchase, Molycorp took on a lot of debt. The buy will give Molycorp more exposure to China, though, which is the world's top consumer of rare earth minerals.
My colleague Travis Hoium isn't impressed with this acquisition strategy, but being vertically integrated can sometimes help buffer a company during rocky periods. Steel giant ArcelorMittal
Molycorp's free cash flow has been negative for several years in a row, and cash flow from operations has been mostly negative.
The stock is also, clearly, very volatile, with an eye-popping beta of 3.92. (Anything higher than 1 suggests that a stock is more volatile than the overall market.) If you're risk-averse and the possibility of sharp drops alarms you, perhaps steer clear. If you're OK with that, keep Molycorp in mind.
Given the reasons to buy or sell Molycorp, it's not unreasonable to decide to just hold off. You might want to wait for the rare-earth prices to rise, or for the company to start reporting a string of net earnings, as it pays down its debt.
You might also want to look at some other mining companies. Cliffs Natural Resources
I'm holding off on Molycorp for now, but everyone's investment calculations are different. Do your own digging and see what you think. Molycorp may perform spectacularly in the future, but remember that there are plenty of compelling stocks out there.
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Longtime Fool contributor Selena Maranjian, whom you can follow on Twitter, holds no position in any company mentioned. Click here to see her holdings and a short bio. The Motley Fool owns shares of Freeport-McMoRan Copper & Gold and ArcelorMittal. The Motley Fool has a disclosure policy.