BHP Billiton - Mega-Cap Value

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 (LON:BLT). 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%.