One of my most important criteria when evaluating a company from a novice’s point of view is the risk of a significant short-term fall, because when that happens early in your career it can sometimes be enough to put you off for life.
Bearing that in mind, there are some cyclical business out there which we can, pretty much for certain, expect to see heading up and down in the short term along with the prevailing economic winds. And if you can deal with that and be sure not to panic when you have a down year, there’s no reason for you to avoid, say, the big miners.
Beyond the cycles
Sure, if you buy BHP Billiton (LSE: BLT) (NYSE: BBL.US) shares and Chinese factory output falls one month you’ll almost certainly see them drop, and if Chinese demand figures show a rise, they’ll probably go up.
But none of that matters if you can look to the long term, and buy the shares as part of a diversified portfolio.
BHP Billiton unearths iron, oil & gas, copper, coal, aluminium… And if demand for those should fall in the future, it will surely only be because we have much bigger problems to deal with than economic cycles — I don’t know about you, but if I’m around when the next asteroid impact is due, I won’t be worrying about my investment portfolio.
One caution that some might sound is that BHP Billiton’s geographic diversity is not as good as it could be, and it’s true that only about a quarter of its revenue comes from North America and Europe. The bulk of the firm’s income is from Asia, with China accounting for nearly a third of the total.
Follow the new wealth
But while that does present some risk, Asia (and China in particular) is home to the largest number of increasingly-affluent consumers on the planet. And if you think Chinese demand in 20 years time is not going to be many times greater than it is today, well, I’m not going to say anything rude about you — but we’ll just wait and see.
Short-term valuation is not a big part of this novices series, but it’s worth a quick look at BHP to get some feel for where it is. On a forward P/E based on forecasts of under 12 it’s below the FTSE average, though miners tend to be a bit less due to that cyclical nature. In the past few years, the P/E valuation has been lower at around 9, and it has been higher at nearly 13, so I really don’t take much at all from today’s figure.
Nice income
A look at dividends is more interesting, with a yield of around 4% currently forecast for the year to June 2014, and that’s not bad at all. Over the past five years it’s been pretty well covered by earnings, so the chances of a cut during cyclical downturns is lowered — although the possibility does have to be factored into any investment decision.
On the whole, I think you’d be buying at a middling part of the cycle right now, and over the long term I can only see demand for BHP Billiton’s earthly delights rising strongly.
And what more can a novice want than that?