More Mega-Cap Value with BHP Billiton

A lot of value investors talk about how you have to look for the unloved, the obscure, the boring and the small. That’s fine if you want to invest in those sorts of companies but personally, I sleep better when I’m invested in big, well known, highly profitable businesses and fortunately these can be value investments too.

For example…

Take BHP Billiton. It’s the world’s largest mining company, a member of the FTSE 100 and is known and followed by droves of equity analysts. On top of that, commodities are a hot topic at the moment so it isn’t exactly out of fashion, obscure or small (its market cap is more than forty billion pounds).

Despite this, its shares have what all shares have – volatility. If you bought shares in BHP at the start of 2007 they would have cost around 930p. By mid-2008, only 18 months later, you could have sold them for anything up to 2,000p for a 100% plus gain.

Of course, I’m not saying that anybody actually made that trade, but it was possible. In fact it could have been done again by buying below 1,000p in late 2008 and selling again over 2,000p in early 2010. That’s two periods of 100% gains in a few short years with a company that the best analysts in the business are looking at all day long. It doesn’t say much for the predictive powers of the market does it?

A short sighted approach leads to a bumpy ride

A major factor in this volatility is that most analysts are only looking at the next year, and sometimes less than that. It’s like trying to drive by looking at the road immediately in front of the bonnet. You’d end up weaving all over the place because you can’t see what’s coming and every time there’s a bend in the road you’d overreact in a panic because you didn’t see it coming. That’s pretty much how the market seems to work.

I prefer to look down the road as far as I can and to do that I need to have a clear view. In terms of investing, a clear view means starting with a company that is more predictable than most.

Can BHP help me to beat a simple index tracker?

With BHP Billiton I have a company which is number 1 in the world; it’s very diverse with good finances and a great track record of growth.  After the market falls of August the shares are down to around 1,900p from a high of over 2,500 in early July.  Not quite as good as the sub-1000p levels seen before, but not bad at all.

Since my benchmark is the FTSE 100 I like to make sure that each investment I make looks more attractive than the benchmark. In this case the numbers stack up like this:

As you can see, BHP Billiton’s investment case relies on future growth more than current returns. The earnings and dividend yields for both the FTSE 100 and BHP are very similar which means that during the next year my returns, either from dividends or earnings per share, are likely to be about the same.

The real difference will come if BHP is able to sustain the level of growth that the numbers suggest. If they do then the earnings and dividends will grow much more rapidly than those of the FTSE 100 and the shares, if they stay at the current price, will become much more attractive with higher earnings and dividend yields. Eventually the shares will be so attractive that it’s almost certain that the price will go up from where it is, and faster than the FTSE 100 is likely to do.

On the assumption that things pan out as above, the projected total returns over 5 years for the FTSE 100, from a starting level of 5,126 are 85%. For BHP, from a starting price of 1,910p the projected 5 year returns are 194%.

The risk of course is that BHP cannot grow as suggested. Sadly, that is the risk which all equity investments carry and it’s something that as an investor I have to live with. Given that the FTSE 100 is effectively a giant conglomerate of 100 leading companies, the diversification which that provides means that I’m more confident that the FTSE projections will turn out to be roughly correct. BHP, despite its size and diversification, is just a single company so the projections are understandably less certain.

To invest, or not to invest

Do the potential gains outweigh this uncertainty? I think they do and as part of a diversified portfolio of above average companies bought at below average prices, BHP could make a reasonable investment.

I’ve added BHP Billiton to both my personal pension and the UKVI model portfolio on Monday 12th September, at 1,910p. The portfolio now looks like this:

Company Description 5yr Return projection
BP 3rd largest energy company in the world. 416%
Tullett Prebon One of the largest inter-dealer money brokers in the world. 330%
Chemring A world-leader in high volume manufacture of a broad range of products for military, aerospace, maritime and security customers. 305%
AstraZeneca World’s #7 pharmaceutical company by revenue. 302%
BAE Systems In 2009 was the world’s #2 military contractor by revenue. 267%
Balfour Beatty A world-class infrastructure services business, currently #15 in the world. 208%
JD Sport The leading UK specialist multiple retailer of fashionable branded and own brand sports and casual wear. 199%
Mears Group Provides maintenance services to Local Authorities and social landlords, as well as being a market leader of home care provision in the UK. 199%
Interserve One of the world’s foremost support services and construction companies. 196%
BHP Billiton World’s largest mining company 194%
Braemar Shipping 2nd largest UK listed ship brokerage. 179%
Reckitt Benckiser One of the world’s largest producers of household products. 164%
Vodafone World #1 mobile telecomms company by revenue. 159%
Robert W Dairies Processes and delivers over 30% of the fresh milk consumed in Britain every day. 140%

Author: John Kingham

I cover both the theory and practice of investing in high-quality UK dividend stocks for long-term income and growth.

3 thoughts on “More Mega-Cap Value with BHP Billiton”

  1. One should consider the ramifications of the real estate bubble in China before investing in a mining company. The prices of some commodities are inflated now because of huge demand from China. However, there will be time, not far in the future, when China will not build huge ghost cities and railroads to nowhere anymore. It will have enough of them. What is going to happen to commodity prices then?

  2. Hi Anon. China is the big question mark with this investment, that's for sure. However, I don't have any idea when they'll slow down, whether it's next year or 10 years from now. Since I only expect to own a company for a couple of years, although 5 years and longer wouldn't be a major concern, I'm not too worried about China.And that's why I like to be diversified too. But anyway, thanks for pointing out the China risk.

  3. Saw this article on Motley Fool:

    So I’m not alone in thinking BHP might be good value. This is an unusual environment for me to be investing in, where the good value shares are well known and talked about. I guess the current level of fear is so strong that even the most likely bargains are too scary for most people or funds to invest in.

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