Since hitting highs of around $49 back in 2008, Australia's largest mining company BHP Billiton Limited (ASX: BHP) has taken shareholders on a rollercoaster ride which has seen the stock recently test decade low levels at $21.61.
For many superannuation funds the destruction in wealth from holding BHP over the past five years has been immense but like all cyclical businesses there is often a great opportunity to purchase these stocks at the bottom of the cycle.
With the share price of BHP up around 12% from its lows in recent days, talk is starting to emerge that a bottom has been reached in the commodity cycle and better times may lie ahead. If this assessment proves accurate then now could ultimately prove a timely opportunity to begin progressively acquiring shares – while acknowledging that the cycle may not trend significantly higher for some time, so building a position slowly could be a sensible approach.
Safety in diversity
One of the aspects to contrarian investing is that it requires an investor to have the courage of their convictions to back themselves and their analysis of an investment scenario.
While there are of course plenty of beaten-up resource stocks that could look tempting to investors – Rio Tinto Limited (ASX: RIO) and Fortescue Metals Group Limited (ASX: FMG) are down 33% and 62% respectively over the past five years – their heavy reliance on a single commodity, iron ore, heightens the risk for investors as they need to get the supply and demand dynamics of this single commodity correct.
In contrast, BHP offers investors a diversified asset base which has the benefit of reducing risks. Based on analyst consensus data supplied by Morningstar, BHP is forecast to earn 60.4 cents per share (cps) this financial year (FY); 71.6 cps in FY 2017 and 111.2 cps in FY 2018. Using these forecasts, the implied price-to-earnings ratio in FY 2018 is around 22 times.
While that PE ratio may not sound cheap, somewhat perversely the time to buy cyclical stocks is when PE ratios are in fact high as this can signify bottom of the cycle earnings. In contrast, the time to sell cyclical stocks is actually when the PE ratio is low as this can imply earnings are towards the peak of a cycle.
