With a long-term pension horizon, you can take advantage of shares that short-termers need to shun.
I like mining stocks like Anglo American (LSE: AAL), which might immediately flag me as a madman in many people’s eyes. So let me first be contrarian and tell you my top two reasons for avoiding the sector.
The first is that it’s a ‘price-taker’ business, by which I mean the producers have no control over the prices they can sell at as their products are totally indistinguishable from the next miner’s. A tonne of copper? It’s exactly the same whoever digs it up and refines it, and the same is true of any specified grade of any earthly commodity.
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My second big red flag is that it’s a wildly cyclical business, with prices of metals and minerals regularly going through big ups and big downs — and share prices go up and down along with them. To many people, that’s just too big a risk to take.
But here’s the thing, which even many professionals fail to grasp — risk depends on your timescale. The longer you leave your money in a cyclical business, the more the ups and downs even out and the better you’re likely to do when looking to supplement the miserly UK State Pension.
5-year return
The Anglo American share price paints an interesting picture. It was crushed during the recent commodities slump when its earnings crashed, but it’s since come back to a five-year price gain of 20%. There have also been dividends totalling approximately 18% on the share price five years ago, so if you’d bought back then you’d have a total return of 38% in five years. Not bad for a ‘risky’ investment.
But it gets even better, and this is another effect of cyclical stocks. If you’d reinvested your dividends during the slump, you could have snapped up super-cheap shares and locked in an even better, effective, long-term dividend yield. It’s a thing called pound cost averaging, and it’s an effect that adds to the long-term returns from volatile stocks.
Right now, analysts are expecting a 10% fall in EPS for Anglo American this year, as global trade war threats and other political stupidity weigh on the honest business of making a living. But that’s put the shares on attractive P/E levels of around 8.5, with dividend yields of about 5% expected.
Tight focus
In the past I’ve also had a liking for Rio Tinto (LSE: RIO), for similar reasons. The shares have been through a similar slump, but their recovery has resulted in a mere 5.5% gain over five years — only very slightly ahead of the FTSE 100, but with a lot more volatility.
Granted, there have been dividends to add to the pot too, bringing the total five-year return up to about 30%, which is still pretty decent. And forecasts put Rio shares on forward P/E multiples of about 10, with dividend yields of around 6% on the cards.
But though I do still think Rio Tinto is a solid long-term investment, Royston Wild makes a very good point that it is far more closely tied to a single commodity than its peers. As Royston says, the iron ore market is responsible for almost 60% of Rio’s earnings, and I’m thinking that’s perhaps too much exposure to a single commodity, even for my long-term cycle-busting approach.
