Why I’m avoiding big-yielding Glencore plc and Barratt Developments plc now

Commodities miner, producer and marketer Glencore (LSE: GLEN) delivered blockbusting full-year results today causing the shares to pop up around 4% as I write. But the real story is the 440% increase in the share price since its January 2016 nadir. If you rode that trend, give yourself a pat on the back for your prescient cyclical trade.

But what now? These figures are stunning. Adjusted earnings before interest, tax, depreciation and amortisation (EBITDA) shot up 44% compared to the year before, and net cash from operations before working capital adjustments lifted 51%. The cash inflow allowed the reduction of net debt by 31% to $10.6bn, which is still a lot of borrowing, but commodity prices are robust, so who cares?

An investing conundrum

On paper, the stock looks attractive. At today’s share price near 400p, the forward price-to-earnings (P/E) rating for 2019 sits at just over 12 and the forward dividend yield at about 3.6%. Chief executive Ivan Glasenberg said in the report: “Our performance in 2017 was our strongest on record, driven by our leading Marketing and Industrial asset businesses.” To mark the occasion, the directors declared a total dividend for the year of $0.20, which works out as a historical yield of around 3.6%.

Higher commodity prices combined with a continued strong unit cost performance to drive up mining margins in the firm’s metals and energy operations. But I think that’s a big part of the investing conundrum now. Things are going well. The shares have risen a lot. However, cyclicals cycle, and if I’d been invested here over the past couple of years I’d be thinking about selling now. I reckon it’s best to buy shares like Glencore when things look bleak and the share price is on the floor and to sell when things look rosy and the shares are riding high.

Meanwhile, housebuilding company Barratt Developments (LSE: BDEV) issued interim results today. This is another cyclical firm where canny investors scored big. If you’d bought a few of the firm’s shares during August 2011, you’d be sitting on a gain of around 640% at today’s 555p.

Beware of the ‘square share’

The figures are good but not spectacular. Revenue is 9.5% higher than the equivalent period the year before, and net profit from operations is up 9.6%. The directors pushed up the interim dividend by 17.8%, which suggests their confidence in the outlook. Chief executive David Thomas said in the report: With good consumer demand, a healthy forward order book and a robust balance sheet, overall we have had a strong first half.”

At first glance, the valuation indicators look attractive. The forward P/E ratio for the year to June 2019 is just over eight, and the forward dividend yield also sits around eight. But hang on, this is now a ‘square share’ and you may remember what happened with the big banks just before the financial crisis last decade when their valuations went ‘square’, with dividend yields equalling the P/E rating — they plummeted.

We never know when the next cyclical plunge will arrive, so why take the risk with cyclicals like these two now? I certainly wouldn’t be stuffing these shares into a long-term portfolio for income.

Where should you invest for 2018 and beyond?

A long-term approach is essential for building wealth. However, I think a long-term approach to holding out-and-out cyclical firms like these two could end up being a mistake.

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Kevin Godbold has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.