I reckon Glencore (LSE: GLEN) has been baring its cyclical teeth. You know, those metaphorical canines that all firms with highly cyclical operations have just for biting investors!
Indeed, a year ago the commodity mining and marketing company’s share price was riding high – going up in a nice trend that looked set to continue. The low-looking valuation and high-dividend yield seemed to support the upwards action. And robust earnings advances were propelling the stock out of the dip it plunged into at the beginning of 2016 when earnings fell off a cliff.
But then the uptrend changed direction. Since early 2018, the stock has dropped by around 27%, which takes the shine of the fat dividend payments investors have been collecting. Earnings growth has stuttered, with City analysts expecting an essentially flat outcome this year and next. Meanwhile, the valuation continues to look tempting. At the recent share price of 295p, the forward-looking earnings multiple for 2020 sits just above eight, and the anticipated dividend yield is more than 6%. Those forward earnings should cover the payment just under twice.
That looks like good value, doesn’t it? I’m not so sure. The company has history when it comes to plunging earnings, and it’s clear that the share price reacts to sentiment regarding macroeconomic conditions. And that’s rational because a big part of the trading outcomes at Glencore is outside its control. The price of commodities on the market plays a big part in whether or not the firm will make a decent profit from operations.
There’s been a share buy-back programme going on but there’s no sign that it’s supporting the share price. If investors fear a downturn in the wider economy, it makes sense to sell shares in an out-and-out cyclical operator such as Glencore, and such selling will drive the share price down. And I think a falling share price attempts to be a leading indicator, occurring before the firm’s earnings actually fall. So, when that happens, it tends to make the valuation look even more attractive.
A lot of risk
However, if we buy the shares based on an attractive-looking valuation like that, after a period of high earnings, we’re really betting that earnings will hold fast or rise higher. But the stock market is trying to predict that earnings will fall, so who’s right? Is it the investor or the market as a whole? Well, I reckon the market represents the sum of all the opinions of the investors taking part in it and, as such, it can be smarter than we give it credit for.
I see limited upside potential and huge amounts of downside risk for investors buying shares in Glencore at the moment. I could be wrong, but I’m not prepared to take the chance, so I’d avoid the Glencore share price right now and seek enduring investments elsewhere.
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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.