I don’t have an investment in big bank Barclays (LSE: BARC), mega-miner Rio Tinto (LSE: RIO) or oil major Royal Dutch Shell (LSE: RDSB). Am I nuts being out of theses shares?
My guess is that these three names attract investors because of their perceived recovery potential, but I’m cautious about their prospects.
Blowing in the wind
The main problem with all three firms is that their operations blow in the winds of cyclicality. As such, they don’t make good buy-and-forget investments that can be tucked away and forgotten about for at least three to five years. Cyclicals like these need to be watched carefully, and timing a purchase of shares is more important than ever.
Take Barclays, for example. The firm is still struggling to recover from the after-effects of the financial crisis. Recent first-quarter results reveal what a big task the firm has winding down its inefficient and often lossmaking non-core operations and assets. The company says it shed £3bn of these undesirable risk-weighted assets in the quarter, but that leaves £51bn still to go.
The pace is slow. Yet Barclays needs to shed the deadweight of non-core assets if it’s to stand a chance of making reasonable overall progress. An increased non-core loss of £815m pulled down an 18% increase in core profit in the quarter of £1,608m to produce an overall profit of £793m for the company. That was down 25% on what Barclays achieved in the equivalent period a year ago — ouch!
I reckon Barclays could get to the point where it has disposed of most of its poor quality operations and straightened out its business only to be hit by another financial crisis down the road. Such roller coaster investing seems too risky to me when there are so many other better potential investments to choose from on the London stock market.
Fickle commodity prices
Meanwhile, Rio Tinto’s shares have been shooting up this year in line with the recovery of commodity prices such as iron ore’s. The way the firm’s share price and profits plunged before that demonstrates how little control the directors have over the company’s profitability. Rio Tinto’s fortunes depend on the fickle movements of commodity prices but speculators and traders exaggerate such movements.
I think that might be why the bounce up in commodity prices, and Rio Tinto’s share price, has been so strong this year — speculation drove prices lower than the balance of supply and demand required, and speculation and short covering drove prices up again too quickly. Royal Dutch Shell suffers from similar forces with its close dependency on the price of oil.
It could transpire that commodity prices continue their recovery allowing Rio Tinto and Shell to generate more cash flow and profits to cover their dividend payments. Equally likely is that commodity prices could slide again and the investment potential of both firms seems uncertain. I think recent price rises have heightened the risk for investors in Rio Tinto and Shell, and those investing now could see a lacklustre investment outcome over a three to five-year holding period.
I don’t think I’m nuts being out of these cyclical firms now because better, more predictable businesses exist on the stock market.