The FTSE 100 has crashed by almost a quarter (24%) so far in 2020, almost entirely due to the economic havoc caused by government restrictions to control the spread of coronavirus. As a result of this falling tide, plenty of cheap shares have risen to the surface.
The hidden dangers of cheap shares
That said, there are plenty of dangers of piling into cheap shares without first doing one’s homework. As a value investor, I am very wary of buying into a company whose shares are cheap for a reason. Hence, it’s important to do due diligence to figure out whether a share is cheap (and nasty?) for good reasons, or genuinely offers value for money.
The simple question I frequently find myself asking is: “This stock appears to fall into the category of cheap shares, but is the underlying business doing well? And is the company well-managed?” If the answers to these questions are both yes, then this is indeed a share to join my watchlist for further investigation.
Cheap shares: I believe BHP stock fits the bill
This morning, I spotted this operational update from one of my favourite cheap shares, BHP (LSE: BHP). Anglo-Australian miner BHP is the world’s largest diversified mining group, digging holes to extract minerals, metals and oil & gas. Based in Melbourne, Australia, BHP employs around 80,000 people worldwide, largely in mineral-rich Australia and the Americas. What’s more, BHP’s products (including iron ore, metallurgical coal and copper, plus oil, gas and energy coal) are sold across the globe.
BHP ticks a lot of boxes for me as a lover of cheap shares. It’s a global leader, a genuine giant in its field with a market value of £91.8bn, making it one of the top five firms in the FTSE 100. It has an experienced and professional executive team and, perhaps most importantly, it has heavy exposure to Chinese demand for raw materials.
Despite Covid-19, BHP is booming
Right now, one of BHP’s main strengths is its market leadership in the extraction of iron ore. In the three months to September, the mining giant produced 74m tonnes of iron ore, which puts it on target to comfortably exceed its full-year goal of churning out 276m-286m tonnes. Indeed, iron ore has been the best-performing commodity of 2020, thanks to its price soaring 28% to hit a seven-year high of around $120 a tonne. Even better news for BHP is that copper, another of its core strengths, has seen its price climb above $7,000 a tonne for the first time since mid-2018.
In short, BHP is enjoying a purple patch, thanks to booming demand in China, combined with greater output and higher prices for its core products. Yet its share price closed today at 1,610.6p, down 2.8p on the day. As a result, BHP’s shares linger 14% below their 52-week high of 1,873p set on 17 January, before the Covid-19 crash. Today, these cheap shares trade on a price-to-earnings ratio of 13.3, for an earnings yield of 7.5%. The chunky regular cash payouts add up to a dividend yield of 5.7%, which is irresistible to me as a value investor. Hence, I’d buy BHP shares today, ideally inside an ISA for tax-free capital gains and a passive income to retire rich!