When it comes to investing, diversity is crucial. That’s because, while we’d all like to think that we have the ability to pick out the very best stocks at the most appealing prices, sometimes things don’t work out as we had planned. That can be due to investor error; not checking out the company in sufficient detail, or it could be as a result of external factors, such as commodity price falls or a change in regulation.
Furthermore, when it comes to the companies we invest in, it can be a major advantage for them to be well diversified. That’s because it can mean a more stable earnings profile, which is generally good news for investors in the stock.
Weakness
This, then, is where FTSE 100 mining major, Rio Tinto (LSE: RIO) (NYSE: RIO.US) has a considerable weakness. Over 90% of its profits are derived from the sale of just one commodity: iron ore. As such, when the price of iron ore falls (as it has done in recent months, with it dipping to a ten-year low), Rio Tinto’s top and bottom lines come under severe pressure, and investor sentiment falls.
Fortunately, Rio Tinto has a very low cost curve and has increased production in an attempt to moderate the fall in profitability, but this strategy is causing the price of iron ore to fall further, thereby lessening its positive impact in the short run.
Diversification
As a result of Rio Tinto’s lack of diversification, it makes sense to pair it up with other mining companies within a portfolio. In other words, if you are looking to gain exposure to the mining sector, just buying Rio Tinto may not be a successful way to do this, since it provides you with exposure to iron ore, rather than mining in general.
Therefore, looking at other commodities makes sense and, although it has not performed particularly well in recent years, gold could be a relatively stable commodity moving forward. Certainly, it may not be as popular as when the financial system was in meltdown, but its price has been relatively robust compared to oil and iron ore, for example.
A Desirable Partner?
One company that has been a strong performer in the last year is gold miner, Acacia (LSE: ACA). Its share price has soared by 38% since June 2014 and, looking ahead, further share price growth could be on the cards.
That’s because Acacia is expected to post superb earnings growth numbers over the next two years. For example, in the current year its bottom line is forecast to rise by 22%, followed by further growth of 64% next year. And, despite having such a superb growth rate, its shares trade on a price to earnings (P/E) ratio of just 17.2, which equates to a price to earnings growth (PEG) ratio of just 0.2. This indicates that, even though they have risen by much more than your typical mining stock in the last year, Acacia could be a star performer over the medium term.
As a result, Acacia seems to be not only a company with substantial capital gain prospects, but makes for a sound partner alongside Rio Tinto within a portfolio. It provides added diversity and, with the performance of gold being more consistent than most other commodities, may provide a degree of stability, too.