It pays to buy what others sell

Oil prices have plummeted since June, 2014. Other commodity prices have declined. This has hurt the share prices of the producers. Oil companies are a lot cheaper than they were. The same is true of many mining companies that we review.

Even so, we continue to rate some of the larger and more diversified producers as buys. This is true of Key stocks Imperial Oil, Suncor Energy and Teck Resources as well as some non-Key stocks. In some cases you can earn relatively attractive dividends while you wait for resources prices to recover.

Is the combustion-engine going extinct?

Only stay out of resources if you believe that the world no long needs them. That is, if you think that the internal-combustion engine is on the verge of extinction; or if you expect homes to no longer require copper for plumbing and wiring.

Sir John Templeton was a highly successful investor. One secret to his success was to buy companies at the “maximum moment of pessimism” about their prospects. Doing so enabled Mr. Templeton to pick up ‘fallen angels’ at great prices. Such may now be the case for resource stocks that can survive short-term and long-term setbacks.

The market’s selling lets you buy low

The wisdom of buying at low prices was confirmed by the research of Professor Jeremy Siegel at the Wharton business school of the University of Pennsylvania. He based his research on the S&P 500 (Standard & Poor’s index of 500 big American companies). In his classic book, Stocks for the Long Run, Professor Siegel writes, “One of the most remarkable aspects of these original 500 firms is that the investor who purchased the original portfolio of 500 and never bought any of the more than 1,000 additional firms that have been added by Standard & Poor’s in the subsequent 50 years would have outperformed the dynamic updated index. The return of the original 500 firms is more than one percentage point higher than the updated index’s 10.07 per cent annual return.

“Why did this happen? How could the new companies that fueled our economic growth and made America the preeminent economy in the world underperform the older firms? The answer is straightforward. Although the earnings and sales of many of the new firms grew faster than those of the older firms, the price that investors paid for these stocks was simply too high to generate good returns.

“Stocks that qualify for entry into the S&P 500 Index must have sufficient market value to be among the 500 largest firms. But a market value this high is often reached because of unwarranted optimism on the part of investors. During the energy crisis of the early 1980s, firms such as Global Marine and Western Co. were added to the energy sector, and they subsequently went bankrupt. In fact, 12 of the 13 energy stocks that were added to the S&P 500 Index during the late 1970s and early 1980s did not subsequently match the performance of either the energy sector or the S&P 500 Index.”

The same was true of Canada in that era. Dome Petroleum became a large company before it went bankrupt. But at present oil producers able to survive the downturn are likely to generate appealing returns during the next upswing in the price of oil.

Terrible timing

It’s extremely hard to ‘time the market’. That is, to buy and sell at the ‘right’ time.

Professor Siegel points out that stocks often get added to the S&P 500 at the wrong time. He writes: “About 30 per cent of the 125 firms that have been added to the technology sector of the S&P 500 Index since 1957 were added in 1999 and 2000. Needless to say, most of these firms have greatly underperformed the market. The telecommunications sector added virtually no new firms from 1957 through the early 1990s. But in the late 1990s, firms such as WorldCom, Global Crossing and Quest Communications entered the index with great fanfare, only to collapse afterward.”

Professor Siegel concludes: “in the capital markets, bad news for the firm often can be good news for investors who hold onto the stock and reinvest their dividends. If investors become overly pessimistic about the prospects for a stock, the low price enables stockholders who reinvest their dividends to buy the company on the cheap.”

Imperial Oil and Suncor Energy—which offer dividend reinvestment plans—come to mind.

 

The Investment Reporter, MPL Communications Inc.
133 Richmond St. W., Toronto, On, M5H 3M8, 1-800-804-8846

Comments are closed.