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Mad punters line up for the next 2500% winner

If you thought the past few years were tough, batten down the hatches…

The stubbornly high Aussie dollar continues to weigh heavily on manufacturing, and low consumer confidence doesn’t help the housing and retail sectors.

And as for the mining boom, the one shining beacon amidst a moribund economy, there’s little doubt it’s as dead as a dodo.

The only doubt is whether mining investment and production — and profitability — gently plateaus at these still massively elevated levels, or the whole sector goes to pot, leaving massive holes in the Australian ground, and a massive gap in the Australian economy.

Still, as you’ll read below, when others capitulate, we see opportunity, and we’ve got our eye on at least one incredibly cheap mining stock.

We readily admit to not having all the answers.

That didn’t please at least one Motley Fool reader, who thought if we couldn’t make a prediction as to where commodity prices might be in 3, 5 or 10 years, how on earth can we be trusted to recommend winning stocks to our paying Motley Fool Share Advisor subscribers?

He might be right. We’re not about to get into a slanging match. Instead, we’re happy to let our scorecard do the talking, over time. But as Motley Fool Share Advisor subscribers will already know, our tips aren’t doing too badly so far.

Back to commodity prices…

We make no apologies for not being able to predict the future.

We can make some educated guesses, but that’s all they’ll be. After all, who’d have predicted iron ore would crash from $US180 a tonne in 2011 down to below US$90 today? Not us, although we have avoided the sector, figuring there was a decent chance iron ore demand wouldn’t be able to soak up the massive supply that was coming to market.

In the mining game, and the investing game, when the wheels come off, the resulting train wreck can be truly spectacular.

You goal, as an investor, should be to avoid train wrecks, for they are the portfolio killers.

That may be stating the obvious, and try as we might to counsel our readers otherwise, we still regularly receive emails like this one…

“The reason why we are all mad punters with the penny dreadfuls is we are all looking for the next Sirius Resources (ASX: SIR). In late July 2012 the shares were trading at around 6 cents per share. They then announce a significant new mineral discovery and I felt it had reached its peak at 30 cents. Now they are trading in the vicinity of $1.50.”

Sirius shares are up an astounding 2500% in the past 6 weeks. Experienced investors can go a lifetime without ever experiencing such a gain, let alone one over such an amazingly short period of time.

Good luck to those who have enjoyed the ride. Anyone investing $10,000 in Sirius at could have seen it blossom to $260,000. It’s one fortune-maker stock, IF you’d had the luck, skill and guts to buy at the bottom and still be holding all your shares today.

For the one Sirius Resources, there are literally hundreds of penny dreadful train wrecks out there in the wild west of resource stock investing.

Call us boring, but when it comes to putting our hard earned cash on the line, we like to put the odds in our favour.

We almost certainly won’t find the next Sirius, but if we can avoid the next 100 train wrecks, we think we’ll be doing a pretty good job for our Share Advisor subscribers and our Take Stock readers.

One large train wreck

Speaking of train wrecks, they aren’t confined exclusively to the penny dreadful sector.

The iron ore sector’s pin-up child Fortescue Metals (ASX: FMG) is a prime example. One week it was plain sailing to expanding annual iron ore production to 155 million tonnes, the next week it had scaled that back to 115 million tonnes, sacked staff and sold an asset.

Worse, with some predicting the iron ore price will stay in the doldrums for some time, the already heavily indebted Fortescue might be forced to raise equity at these heavily discounted prices – or even lower. No wonder Morningstar have cut their fair value estimate to just $2.20, putting a sell recommendation on the stock.

On the other hand, according to The Australian Financial Review, Citi is maintaining its buy rating on Fortescue, trimming its price target just a smidgen from $5.00 to $4.90.

The value hounds will be salivating at Citi’s earnings forecasts which place Fortescue on a 2015 forward price to earnings (P/E) multiple of 3.5.

We love a bargain, just like most investors. But this is no lay down misere — far from it. Debt can kill, and Fortescue is swimming in the stuff, and with the future of iron ore prices as uncertain as ever, we’re steering a wide berth.

If only it was this easy…

If only investing was as easy as buying ‘cheap’ stocks. You’d run a simple screen, buy the cheapest, and sit back and wait for the value to be outed. Rinse and repeat…

Out of interest, I ran such a screen using S&P Capital IQ, our very powerful data sourcing software. On a pure P/E basis, there’s no shortage of ‘cheap’ stocks, like these selected examples…

Company Recent Share Price Trailing P/E
Rio Tinto (ASX: RIO) $50.22 8.6
Illuka Resources (ASX: ILU) $8.60 6.6
David Jones (ASX: DJS) $2.39 9.4
JB Hi-Fi (ASX: JBH) $8.99 9.5
Ausdrill (ASX: ASL) $2.79 8.5

Source: S&P Capital IQ

Cheap? Yes. Buy recommendations? Not necessarily.

Cheap stocks can always get cheaper, especially if they are laden with debt, operate in intensely competitive sectors, are capital intensive, and are price takers.

Still, there are always exceptions to the rule. For example, we’ve got a keen eye on an emerging copper producer that one broker estimates is trading on a forward EV/EBITDA multiple of 1.

One baby with multi-bagger potential

No, that’s not a typo. The number is 1. If the broker is even close to being right, we still won’t be looking at the next Sirius, but we could be looking at a stock with multi-bag potential.

Sirius apart, many commodity stocks are in the doghouse, and justifiably so. The mining boom being over hurts our economy, and our producers, and it absolutely obliterates any small company looking to raise capital to continue their highly speculative mining exploration activities.

But as is so often the case, a few healthy babies are often thrown out with the dirty bathwater. And what’s not to like about a clean, healthy baby trading on a forward EV/EBITDA multiple of just 1?

If you’re looking for a little spice for your portfolio, we have a free report that might be right up your alley. These stocks are not for the faint hearted. But if you enjoy the thrill and excitement of the occasional high-risk high-reward investment, they could be for you. Click here now for instant FREE access to “The Motley Fool’s Top 2 Biotech Stocks To Buy Now“.

Motley Fool General Manager Bruce Jackson does not have an interest in any companies mentioned above. The Motley Fool‘s purpose is to help the world invest, better. Take Stock is The Motley Fool’s free investing newsletter. Packed with stock ideas and investing advice, it is essential reading for anyone looking to build and grow their wealth in the years ahead. Click here now to request your free subscription, whilst it’s still available. This article contains general investment advice only (under AFSL 400691).

 

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