Is it Wise to Invest in the Business of Bling?

Ryan is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

I've never been much of a fan of investing in precious metals and stones. Such things derive most of their value from the price that the rich are willing to pay for them. I would much rather own companies that provide valuable services that genuinely improve the quality of human life. Enterprises like Waste Management and Procter and Gamble make my life immeasurably better, and I like owning businesses that do that.

Just because I don't think something has value doesn't mean others won't.  So lets see if there any companies in the business of bling that deserve your investment dollars.

For the 49er in all of us

Gold miners have seen their stocks take a beating recently, but I still find IAMGOLD (NYSE: IAG) to be an interesting investment idea. Right now it yields 6.1%, with a payout ratio of only 41%.

With a market cap of $1.7 billion IAMGOLD is much smaller than the largest gold miners in the world. In fact, the largest gold mining company in the world is Barrick Gold (NYSE: ABX), which is about 10 times bigger than IAMGOLD.

And yet IAMGOLD has much better margins than Barrick. The five year average net profit margin for IAMGOLD is 25.4%, compared to just 6.6% for Barrick.  You have to love seeing the little guys outperform giants.

Turning to the balance sheet, you will notice IAMGOLD's cash and equivalents stand at $648 million, and it has $215 million worth of gold bullion. With current liabilities of only $317.9 million, I can't see IAMGOLD piling on debt anytime soon.

IAMGOLD is also selling a substantial discount to book value. Its price to tangible book value is 0.44, compared with 1.19 for Barrick. Most of the tangible book value in IAMGOLD is, of course, in assets that derive most of their value from the market price for gold. The market price for gold has been nosediving, and has a future wrought with uncertainty. Such a large discount to tangible book provides a nice cushion.

All that glitters is not gold 

Diamonds also glitter, and if you believe the marketing, they are forever. For a very long time De Beers, which is 85% owned by Anglo American, (a large British mining company) had a complete stranglehold on the diamond market.

Times have changed, though, De Beers has seen its market share decline from nearly 90% in the 1980's to less than 40% today. During this time other miners have moved on the scene, among them multinational mining giants Rio Tinto and BHP Billiton.  As of April 10, 2013 BHP is no longer in the diamond business, having sold all of its diamond related assets to Dominion Diamond (NYSE: DDC)

Most of the world's diamond mining activities comes from large multinational mining companies for whom the diamond business is only a small piece of their pie. This means that there are very few pure plays on diamonds out there, but one does exist in Dominion Diamond. 

At first glance, Dominion Diamond Corporation looks pretty cheap. You don't see a company with a price to earnings ratio of 2.46 very often. Its price to tangible book ratio sits just below one. Purchasing a solid company for less than book value is always a treat, but is Dominion Diamond a solid company?

It does have pretty astounding gross margins, but as we all know gross profits are not what flow into investors' pockets. Dominion's average net profit margin, over the past five years, has been 3%.

What's more, that ultra low price to earnings ratio is incredibly misleading. The ultra high net income Dominion recorded this past quarter was by way of a one time occurrence. It sold its luxury brands division for $497.6 million. Net income from continuing operations was a measly $2.26 million. If you factor out that one time, super boost to net income, the price to earnings ratio shoots up to 108.7. Yikes!

Foolish final take

Investing in assets like gold or diamonds, or the companies that produce them is much riskier than investing in a business or product that actually makes something. The reasons for this are obvious. The world isn't going to stop consuming pharmaceutical products, oil, or Coke.

That being said we have two companies here in the business of bling.  One of them, Dominion Diamond, has demonstrated little profit generating power. Even though it's selling at a bit of a discount to book and has taken steps to strengthen its position in the industry, you should stay away. 

On the other hand, IAMGOLD seems fairly attractive right now as it sells for less than half of its tangible book value. Normalized net income, (which factors out special charges), has been well in the black during each of the past 4 years. That yield also looks pretty scrumptious.  Perhaps it's time you take a look at this embattled gold miner. 

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Fool blogger Ryan Palmer has no position in any of the stocks mentioned. The Motley Fool does not recommend or own any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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