long-term investing News | The Twelfth Magpie

This share grew 5,000% in 12 years! Why I focus on long-term investing

James Reynolds — Tue, 22 Feb 2022 07:12:28 +0000

Long-term investing can be difficult to wrap one’s head around at first. It’s not always easy to plan 10, 15 or 20 years in the future. But I believe the potential benefits of this sort far outweigh any other strategy. Especially in times of market uncertainty.

Since the last big crash, thousands of companies across the world have seen their shares grow by double, triple, or even quadruple digits. The past is not a predictor of the future, but it can reveal patterns that savvy investors can either take advantage of or use to keep a clear head.

The poster child of long-term investing

Berkshire-Hathaway is the American conglomerate under the stewardship of famed investor Warren Buffett. Buffett has been at the helm since 1965 and has steered the company through multiple crashes and periods of contraction. However, Berkshire has always managed to stay on top. Between 1965 and today the company’s A-shares have grown from $19 to over $470,000 each. In that time there have been roughly seven market crashes in the U.S.

I can only imagine the horror of those who sold their shares during those crashes. Or those who were put off investing because they weren’t thinking of the long term. The company’s B-shares have grown 452% since 2009, and although this is no guarantee for the future, I see no reason why they can’t see similar growth over the next 10 years. Buffett’s tenure at Berkshire Hathaway will undoubtedly come to a close at some point, but I trust that he and the board have a suitable successor in mind.

Tech is here to stay

Another, more recent example could be Amazon. The Covid-19 pandemic has seen the online retail and media company rocket into the stratosphere, but it’s worth noting that it first debuted on the stock market at $1.97 back in 1997. Amazon was one of the few internet companies to survive the dot-com bubble, but it also held up remarkably well during the 2008 financial crash. At that time, shares were worth just $50 each. How much are they now?

$3,052.

That’s a growth of roughly 5,000% in just over 10 years.

Again, not every company can be Amazon, but the point remains that investors who held onto those shares or even bought them as prices fell have made a small fortune. This is what characterises the risk-reward factor with investing. Yes, when investing in stocks your capital is at risk, but I feel that as long as I focus on the long term, do my research, and keep a level head when times are tough, I stand a good chance of coming out on top.

Stock market volatility

There’s not much I can do about the macro factors which affect the stock market. No one can be sure when there will be a pandemic or tensions boil over into war. But I also won’t let fears of these things prevent me from investing. What I can do is work to focus on the long term. I’m certainly not immune to the fears of a market downturn, but so long as I keep my focus on 10 or even 20 years in the future, I know I can weather whatever storms come my way.

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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. James Reynolds owns Berkshire Hathaway (B shares). The Motley Fool UK has recommended Amazon. 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.

Investing in your 20s? Here’s what I’d do

Thomas Carr — Fri, 25 Sep 2020 10:00:14 +0000

The earlier we start investing, the better. The best time to start investing is actually when we emerge from the womb. But that’s too late for anyone reading this and our 20s represent the first real opportunity that most of us have to start.

Our 20s are a time when many of us start work and receive our first salaries. It’s also a time when we start to think about building for the future and taking financial responsibility. In terms of building financial wealth, investing in the stock market may not feel like a priority, but it’s the best option for most of us.

Why invest in your 20s?

Investing early allows our investments to compound over time. Simply put, that means we earn interest on our interest. And time is an investor’s best friend. The longer we hold shares, the better they perform. Holding decades allows us to ride out any bear markets and recessions – like the one we’re in right now. Over this kind of timescale, shares invariably move up, tracking economic growth. If we start investing regularly in our 20s, then we have the potential to make huge gains by the time we’re 60. More than anything else, this really is the path towards early retirement and financial freedom.

In theory, investing in our 20s means that we can take on more risk. There’s plenty of time for our investments to recover if they falter early on. But we need to be careful how we view risk. When I say we can take on more risk, what I mean is more risk for a given return. If we want to maximise our returns, then we need to manage risk properly.

Buy quality

It’s not an open invitation for us to start investing in speculative miners or oil exploration companies. Instead, we need to be investing in quality companies that are able to grow sustainably over a period of many years. This is the best way to make the most of the extra time we’ve got. Otherwise we risk wasting our early start.

The way that we can take on more risk is by investing in growth companies that are maybe on the more expensive side. What seems fairly expensive today, may be a bargain in 20 or 30 years’ time. When investing with such a long timeframe, we don’t need to be quite so focused on price. Investing in our 20s therefore gives us more flexibility.

It’s also important that we still diversify by investing in a number of shares, not just one or two. I’d recommend at least 10. Along with time in the market, diversifying the number of holdings is a great way to improve long-term investment performance. If one company fails, there are others that can fill the void.

All in all, investing in your 20s isn’t completely different to investing in your 50s. We can afford to pay a little more and target the sort of growth companies that can really outperform in the long run. But we should still be focused on quality companies and on diversification. The most important thing is that we start investing early and invest regularly. This is what will create the biggest gains.

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Thomas 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.

How to navigate the FTSE 100 near all-time highs

Zach Coffell — Wed, 25 Oct 2017 11:08:58 +0000

The FTSE 100 is hovering near all-time highs and such milestones naturally inspire introspection among investors. For one, it highlights that valuations are perhaps fuller than they have been in recent years and gives the impression that markets could be a little overpriced.

With that in mind, what changes, if any, should we make to our investing strategy as the index enters uncharted territory?

In my opinion, now is the perfect time to get back to basics, including safeguarding your life outside of the markets. Now could be the perfect time to build up that emergency fund you’ve always known you should have, just in case life throws up any unexpected costs.

In the unlikely event of a market crash, or a far more likely correction, you don’t want to be a forced seller just because you got greedy while the going was good.

In fact, I’d be tempted to go a little further and build up some dry powder in the brokerage account too – I’m thinking 15%-20%. That might sound overly bearish, but research shows that markets pull back on a surprisingly regular basis before eventually climbing to new highs. Having a little cash on the side might be the difference between snapping up that share that always seemed a little too expensive and lamenting the loss of a bargain.

I’d also suggest investors reappraise their current holdings. Given that some valuations are indeed looking generous, now could be the perfect time to rid your portfolio of any positions you don’t have solid beleief in. As Warren Buffett advises: “Unless you can watch your stock holding decline by 50% without becoming panic-stricken, you should not be in the stock market.”

Believe in your purchases

I truly believe the best way to navigate new stock market highs is to stick to a long-term buy-and-hold approach. If you believe a company will be worth far more in 10 years than it is today, you wont feel the need to bank gains when it looks slightly overvalued. It’ll also make dealing with those calamitous 50% collapses easier, which you will experience at some point over your stock picking career if you do it long enough, even though they are thankfully rather rare.

In summary, there’s nothing wrong with taking a little risk off the table in these conditions, especially if the resulting cash reserves facilitate a high-conviction buy once valuations seem more appealing.

If you have a lot of capital to invest, however, there’s no point sitting on the sidelines.

If you’re finding valuations a little nervy, I’d advise the tried-and-tested strategy of pound-cost-averaging into a tracker fund over time by investing a fixed amount at regular intervals (say, once a quarter) regardless of what the market is doing.

If you’re still interested in stock-picking then I suggest you maintain exacting standards from both valuations and business models. Buffett recommends investing as if you only have a limited amount of buys left in your investing career and that’s particularly sound advice in the current market. He says: “I could improve your ultimate financial welfare by giving you a ticket with only 20 slots in it so that you had 20 punches – representing all the investments that you got to make in a lifetime. And once you’d punched through the card, you couldn’t make any more investments at all.”

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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.

Two dividend stocks you can retire on

Zach Coffell — Sun, 22 Oct 2017 06:00:28 +0000

In my experience, investors are far too preoccupied with picking ‘cheap’ companies, perhaps driven by Warren Buffett’s advice to be greedy when others are fearful. This bargain hunting often comes at the expense of owning quality companies, however.

If you truly want to get rich in the long term, I believe you should spend more energy searching for quality businesses than for low P/E ratios. With that in mind, here are two stocks I believe have the business models to keep the payouts coming.

A deluge of dividends

International beverage behemoth Diageo (LSE: DGE) has posted impressive dividend growth over the years. The payout has increased threefold since 1999. That’s a compounded annual growth rate of 9.65%.

The company’s drinks, ranging from Captain Morgan’s to Guiness, are cash-cows that provide it with a fairly steady stream of income to expand its portfolio and develop acquired brands.

Diageo can build a brand with potential into a global powerhouse by employing its global structure (which includes huge marketing power and a vast distribution network) to increase the product’s reach and image.

In recent years, the company has disposed of non-core assets to focus on what it does best: selling spirits and beers. Removing distractions such as the small wine segment, which accounted for roughly 4% of revenues, is a step forward in my opinion.

That said, I’m not sure that now is the perfect time to buy Diageo. It offers only a 2.4% yield to prospective investors and the rate of dividend expansion is a little lower than the historical average at only 5% last year, although you only have to go back a few years to see the last double-digit hike.

I’d begin considering the shares for inclusion in a life-long portfolio if the yield topped 3%. That said, investors who bought the shares back in 1998 and still hold today are receiving a 10% annual return from the dividend alone, demonstrating the power of holding quality companies for the long term.

Quality I’d buy today

UBM (LSE: UBM) is one of the world’s largest trade show operators. Believe it or not, this seemingly boring operation provides the perfect economics for churning out big dividends.

Despite technologies like Skype making inter-business relations easier than ever, there is still no substitute for trade shows that bring together the top players in each industry. Of course, no one wants to jump from show to show because nothing would ever get done, but this aversion towards unnecessary shows actually plays right into UBM’s hands.

The company has carefully built a portfolio of must-see events that are attended by all industry leaders, allowing customers to only visit one or two key shows a year. Perhaps the strongest aspect of these shows is that customers book up months in advance, so UBM not only receives cash well in advance of serving its product, but can manage costs to remain profitable even when turnouts are low.

If you want to see this dynamic in action, check out results for fellow trade show operator ITE Group. It has remained remarkably resilient in recent years despite awful conditions in its primary markets.

UBM shares offer a 3.2% yield to investors today and management has vowed to hike the dividend at a faster rate to reflect the success of its ‘events first’ strategy.

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Zach Coffell owns shares in ITE Group. The Motley Fool UK has recommended Diageo, ITE Group, and UBM. 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.

Smash profit warning paralysis with this three-step guide

Zach Coffell — Sat, 14 Oct 2017 07:44:06 +0000

It’s a morning like any other. You awaken gently, throw open the curtains, stick the kettle on and settle in to catch up on the morning news.

But this peaceful routine is just the calm before the storm. Just a few clicks away it lurks, ready to pounce. When it hits you – and hit you it will – you freeze as your retirement drifts further into the future.

I’m talking, of course, about profit warning paralysis. I’m being more than a little dramatic too, but I’m sure every investor out there has felt uncertain in the face of bad news. Deciding whether or not to sell, or perhaps even buy, more shares can feel like an insurmountable task.

If you find yourself panicking after a profit warning, fear not. We’ve designed a pragmatic methodology to help you separate the irrelevant from the irreversible. The next time you find your critical faculties overwhelmed by sudden negative news (and it happens to the best of us) simply work through this three-step survival guide.

1. Is the investment thesis still intact?

Every time I make an investment, I create an investment thesis – a small paragraph that explains exactly why I’m buying the share. For example:

“I bought company x because I believe its superior product can prosper overseas.”

If you’re investing for the long term, having a thesis for each stock you buy is incredibly important, because it helps you focus on what is important. If the reasons behind the profit warning scupper your investment thesis, it is probably time to move on and sell the shares.

If you haven’t already, perhaps you should clarify the investment thesis behind each of your investments.

2. Quantify a worst-case scenario

If step one didn’t help, I’d advise you try to quantify the profit warning. If the announcement uses vague terminology such as “significantly behind expectations” you should try to put a number on what a worst-case scenario might look like.

For example, a company I follow recently warned on profits because one of its major clients had declared bankruptcy. After sifting through the annual report, it seemed clear that no single client accounted for more than 10% of revenues, so that became my worst-case scenario. As a result, I’m considering buying up some of the shares.

Putting a number on the downside will remove that fear of the unknown and help you make a considered decision.

3. Go for a walk.

If step one and two haven’t banished the nerves, I’d recommend getting away from the computer screen. Go outside, play some sport or read a book. Just get your mind away from the news for a while. Perhaps sleep on it. Decisions made in a panic are almost always poor, so ensure you regain control of your critical faculties before doing anything at all.

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2 dividend stocks for the long haul

Jack Tang — Mon, 31 Jul 2017 14:07:00 +0000

Dividend investing is a popular strategy to build long-term wealth, but it’s important to remember that yield is not the only factor to consider. There are many high-yielding stocks out there, but if you’re looking for reliable stocks for the long haul, it’s often best to look for quality companies with strong fundamentals and steadily growing dividends.

Dividend growth

Lloyd’s of London insurer Hiscox (LSE: HSX) is one such example. The Bermuda-incorporated insurer is set to lift its interim dividend by a penny per share to 9.5p, in a move which brings it closer to fulfilling management’s target dividend growth of 15% this year. This gives shares in Hiscox a prospective yield of 2.4% at the current share price.

The insurer said this morning that the net premiums earned during the six months to 30 June rose by 22% to £936.6m. This helped pre-tax profits, in constant currency terms, to climb 12% against the same period last year, to £133.5m.

When foreign exchange movements were taken into account, the figures looked a lot less cheerful as statutory pre-tax profits fell by more than half to £102.6m. However, it’s important to remember that currency volatility is only a short-term issue. Long-term fundamentals remain broadly intact, with the underlying combined ratio (a key measure of underwriting profitability), up by just 1.5 percentage points, to a still impressive 89.9%.

One of the key attractions of Hiscox is its growing retail business, which once again was its standout performer. The growth in retail continues to offset much of the weakness from its specialist London insurance business. Gross written premiums there declined 8% in the first half, compared to a 27% increase from the retail segment.

That’s because the pricing environment for larger premium, catastrophe-exposed lines remains tough as rating pressure continues amid excess underwriting capacity and historically low loss ratios. On the upside however, Hiscox had minimal exposure to some high-profile losses in the industry this year, including the Grenfell Tower fire and Cyclone Debbie, which hit Australia in March.

Demographic shift

Elsewhere, newly-listed Impact Healthcare REIT (LSE: IHR) could be a great pick for investors looking for long-term exposure to the property market. As an investor in residential care homes, this REIT looks set to benefit from two ongoing tailwinds, namely an ageing population and the chronic shortage of suitable properties for caring for the elderly.

The REIT’s property portfolio currently consists of 57 residential care homes, following the acquisition of the Seed Portfolio and Saffron Court in Leicester in May and June, respectively. And as is typical for the sector, Impact Healthcare benefits from long lease terms with upwards-only annual RPI-linked rent reviews. This enables the REIT to earn steadily-growing income and gives it significant protection against a potential downturn in the property market.

Looking ahead, the company sees a strong pipeline of attractive new potential investment opportunities, which includes further acquisitions and asset management opportunities. Subject to financing, it is set to move forward with plans to expand three of its existing homes to create 92 additional beds. With no debt in place at present, Impact Healthcare surely has plenty of potential for growth.

Shares in the REIT currently trade at a 5% premium to its net asset value, with a prospective dividend yield of 5.8% this year.

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Jack Tang has no position in any 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.

2 small-cap stocks you could buy today and never sell

Zach Coffell — Thu, 23 Feb 2017 12:54:33 +0000

Quickfire trading for fast profits is an alluring strategy. Many financial commentators will advise you buy a stock because it looks a little undervalued, but instead of flipping stocks for a 10% gain here and 20% profit there, I reckon most investors would be better served playing the long game.

The Sage of Omaha, Warren Buffett, has admitted his favourite holding period is forever because it allows your returns to compound and avoids the attention of the taxman. With that in mind, here are two companies I’d be willing to buy and hold if the market were to close down for 10 years.

A helping hand for healthcare administrators

The US healthcare system is a complicated beast. A hospital can provide a myriad of services, making billing a difficult process prone to human error. For example, a central list of billable items could contain upwards of 40,000 items.

Edinburgh-based Craneware (LSE: CRW) offers hospitals a range of solutions to aid administrators. Its software makes picking the correct treatment codes easy and streamlines reimbursement processing when dealing with government-funded programmes like Medicaid.

In short, the software saves hospitals time and money. Craneware has grown profits eight-fold since 2007. It made $10.6m profit on $50m in revenue last year, for a net income margin of 21.1%. Return on capital has averaged 17.2% over the last five years too and the balance sheet is sound, boasting a $48.8m net cash position.

Trump is planning on repealing and replacing Obamacare, which could change the healthcare landscape in the US. So will that hurt Craneware? Well, its sales actually increased after the election results. These contracts average five years, indicating that hospitals still believe the software will be useful in the future. The healthcare system will likely be insurance-based regardless of what happens, so I believe the firm will remain relevant.

Throw in visible and recurring revenues, a dollar renewal rate of over 100% and strong scalability and I think it could outperform the market for years to come. The company currently trades at 30 times free-cash-flow, but I reckon the aforementioned qualities justifiy this rating. You’ll get a 1.5% yield while you wait too.

Picks and shovels for the gaming boom

The global video games industry is expected to grow at a CAGR of 5% over the next few years and could be worth as much as $90.1bn in 2020.

Video games are getting more complicated as it grows and I reckon these factors bode well for Keywords Studios (LSE: KWS), a picks and shovels play on this rapidly expanding industry.

Big games developers outsource a number of services to Keywords, including voice acting and recording, games testing and localisation services, including the translation of speech, marketing and packaging into different languages.

Historically, these services have been provided by a number of tiny companies. Keywords is now consolidating this fragmented industry and is the largest service provider in its niche. It acquired eight businesses in 2016, including Synthesis, expanding its skill set into audio services.

The company has worked with 21 out of 25 of the top games companies by revenues, including Sony and Electronic Arts. I believe it can become the largest service provider in the rapidly growing global gaming industry. A forward PE of 30 is demanding but I think the company’s dominant position and industry tailwinds justify this.

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Zach Coffell owns shares in Craneware. The Motley Fool UK has recommended Craneware and Keywords Studios. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

How to avoid lagging the market as a new investor

Zach Coffell — Sun, 29 Jan 2017 08:16:20 +0000

I’m not one for eavesdropping, but as I sat in a coffee shop last week I overheard a brash and booming business meeting being conducted a few tables over. “Half of selling,” said a suited up fellow, “is knowing the correct technical terms to impress.”

What were they discussing? Perhaps unsurprisingly, it was a financial product. Aside from making my blood boil, this conversation reminded me that much of the financial industry exists to bewilder, to bewitch and to befuddle you.

The more complicated finance seems, the more likely you are to outsource wealth management to highly profitable financial institutions.

If you’re new to investing and lagging the market, it might not be your fault. There’s so much information out there and most of the pros want to keep their secrets locked up.

Today I’ll try to demystify the apparently complicated, yet wonderfully simple world of investing. Here’s a few pointers that might help you get to grips with this deliberately opaque industry.

Have a simple plan

Some fund managers will try to impress by talking about hedging, shorting, derivatives etc… but you can completely ignore all these complicated and often unnecessary practices and still make a killing by following three easy steps;

Buy a diversified portfolio of good companies
Hold them for a long time
Profit

That’s all there is to it, but let’s break those steps down a bit more.

What’s a great company? In my opinion, they all share one kind of asset, a durable competitive advantage. This is a feature, be it a great leader, a great product, a great brand, that sets the company apart from the competition. Most importantly, this feature must be sustainable in the long term.

Coca-Cola has been outselling other drinks for decades and out-performance has followed. That’s a durable brand. If the advantage isn’t durable, the share price appreciation caused by it might not be either.

I recommend holding around 15 great companies whose operations span different sectors and geographies to ensure you spread risk. Holding these companies for years rather than days reduces dealing costs, which at £10-£15 a pop can seriously erode your wealth.

It’s a numbers game, kind of

You need a basic grasp of accounting to find great businesses, but you don’t need to be conducting discounted cash flows in your sleep to be successful. Not even Warren Buffett, who owns many great companies, employs these complicated tools. Accounting can be scary and you’ll have to do a little bit of research to understand it, but only a little.

The wonderful book Warren Buffett And The Interpretation Of Financial Statements will teach you almost everything you need to know in an incredibly accessible and contextual style. In case you’re wondering, I’ve not been sponsored to say that. In my opinion it’s the best book to help beginners find financially great businesses.

You’re human, dispel your ‘animal spirit’

You’re not a bull, nor a bear. You’re a rational human being with emotional control. Buffett’s partner (and my hero) Charlie Munger often talks about the psychology of human misjudgement, or what makes us screw up. In short, the human mind isn’t wired to invest, resulting in wealth-eroding errors. Being aware of these in-built flaws will prevent you falling afoul of them.

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2 top buys for long-term investors

Ian Pierce — Thu, 06 Oct 2016 10:02:16 +0000

What are the best qualities to look for in long-term holdings? Well, we’d all be rich if we knew exactly what the secret recipe was, but there are a few characteristics that many great investors love to see in their biggest holdings.

Chief among these are a wide moat to entry for competitors, impressive margins, steady dividends and solid growth prospects over many years. There aren’t many shares out there that tick every box on this checklist, but one that does is British American Tobacco (LSE: BATS).

The wide moat to entry in the tobacco sphere includes not only the capital-intensive business of manufacturing and distributing cigarettes, but also the intense loyalty smokers have towards their chosen brands.

Customers aren’t about to switch from smoking Lucky Strikes simply because the price increased 10p a pack, for example. This gives BAT incredible pricing power, which is a large reason operating margins were a fantastic 36.8% over the past half year.

High margins play a big role in generating significant cash for BAT, which the company dutifully passes on to shareholders through annually increasing dividends that yield 3.09%.

As far as long-term growth goes, the already massive tobacco industry obviously isn’t about to take the world by storm. However, increasingly wealthy developing markets are big consumers of cigarettes and were a major reason organic volume growth for BAT was an impressive 2.1% year-on-year over the last six months.

There are obviously risks to BAT from increased regulation in the developed world, but the company has adapted to these before and I see little reason to believe this will change in the future. With growing revenue, little threat from upstarts, healthy margins and substantial shareholder returns, BAT is one share I wouldn’t mind owning until retirement.

One for good times and bad times

Another company that has earned its place in many retirement portfolios is consumer products giant Unilever (LSE: ULVR). Like BAT, Unilever’s wide moat to entry is filled with household names that consumers buy in good and bad times alike, such as Dove, Lipton, and Ben & Jerry’s.

Selling goods to which consumers have a personal connection ensures both stable revenue and enviable pricing power. The ability to charge high prices and a strong focus on operating costs led to operating margins of 14.4% over the past six months.

This is a decent result for a consumer goods company, but offers significant room for improvement. Unilever is already working on this by shifting away from low margin food products towards the more profitable personal care sector of soap, shampoo and the like.

Dividends have been on the rise for several decades at Unilever and shareholders now get a 2.64% yield that is covered 1.4 times by earnings. Higher shareholder returns in the future will, of course, rely on Unilever growing the top and bottom line.

There’s very good news on this front as its high exposure to emerging markets, which now account for more than half of sales, is leading to very good growth. Over the past six months alone sales grew 4.7% year-on-year, not a bad result for a company with over €50bn of revenue annually. Solid growth, steady dividends and a management team intent on boosting margins leaves me optimistic that Unilever will continue to be a solid company for a long time to come.

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Ian Pierce has no position in any shares mentioned. The Motley Fool UK owns shares of and has recommended Unilever. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

3 Reasons To Be Bullish On Rio Tinto plc & BHP Billiton plc

Jack Tang — Fri, 22 Apr 2016 15:24:06 +0000

With oversupplied commodity markets, 2016 looks set to be another tough year for mining sector. But here are three compelling reasons to be bullish with two of the best-placed miners: Rio Tinto (LSE: RIO) and BHP Billion (LSE: BLT).

1. Cost leadership

Competitive strength is one of the most important factors to look out for when making long term investment decisions. With little product differentiation in the natural resource sector, mining companies can only achieve competitive strength through one strategy – cost leadership.

Precisely because of this, Rio and BHP are market leaders for a wide range of commodities, including iron ore, copper, coal and bauxite. Thanks to a focus on massive projects, these two firms benefit from economies of scale and high levels of productivity. Their production costs are at the very low-end of the cost curve for most commodities.

This gives them a competitive advantage over their rivals and enables them to generate wider margins and excess returns throughout the cycle. Rio enjoyed an adjusted EBITDA margin of 34% in 2015, while BHP’s margin was 40%. This compares very favourably to Glencore and Anglo American, which have adjusted margins of 16% and 21%, respectively.

2. Expanding production

An increase in production may be the last thing that the sector needs right now, but when you have one of the lowest production costs in the industry, expansion leads to greater profitability even though it puts further downward pressure on market prices. Furthermore, lower commodity prices in the meantime may actually help low cost producers in the long term. Lower prices should push out the more expensive producers, which reduces supply in the market and lends support to higher prices in the longer term.

Although the market is currently massively oversupplied, some commodities may actually transition to a supply deficit by the end of the decade. Many analysts still have positive long term views on base metals, particularly copper and nickel, because large-scale mines for these commodities are ageing. This causes productivity from these mines to fall, and potentially could cause global supply to decrease.

There is a scarcity of large projects coming onto the market over the next several years, and BHP and Rio are the few miners with big development projects. Rio is particularly attractive, because it has better upside production potential coming from its mega projects, Oyu Tolgoi and Pilbara, which produce two of its most profitable commodities – copper and iron ore.

3. Strong balance sheets

BHP and Rio may have recently cut their dividends, but their balance sheets remain robust. With net gearing below 30%, they are both in a unique position to benefit from mergers and acquisitions (M&A). This is a huge potential positive because today’s low asset prices and the lack of bidding competition makes it a buyer’s market. M&A could bring greater scale and bargaining power, which could further improve their competitive advantage in the long run.

Although both companies will still face some short-term obstacles, their strong balance sheets gives us confidence that both companies are well-placed to cope with lower prices for longer. It’s near impossible to time the bottom of the market, but at least we can be confident that BHP and Rio have the financial flexibility to ride out the commodities supercycle.

The post 3 Reasons To Be Bullish On Rio Tinto plc & BHP Billiton plc appeared first on The Twelfth Magpie.

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Jack Tang has no position in any shares mentioned. The Motley Fool UK has recommended Rio Tinto. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.