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Can the Anglo American share price smash the State Pension?

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.

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.

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Alan Oscroft 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.