There's a belief when investing in property that buying the worst house in the best street can pay off. The theory goes that demand for the street should increase the value of your land holding, but can this be applied to the sharemarket?
During unprecedented times like the mining frenzy of the late 2000's it could and would have worked. For example, buying cheap speculative explorers (the worst house) during the frenzy would likely have paid off because mining stocks were the place to be (the best street).
How times have changed!
I saw a statistic the other day that around two-thirds of non-producing mining companies (there are a lot of them) have less than $2 million in cash. We could yet see the demise of a huge number of companies in the next 24 months if investor appetite for riskier mining stocks doesn't return.
The best house in the worst street…
Many property investors will warn you off using the above strategy, the problem being that the houses either side of you, decrepit with a beaten up ute in the driveway, will bring down the value of your holding.
In the sharemarket however, scooping up the best companies at times when a whole sector is out of favour can pan out beautifully over the medium to long-term. The best example of recent times is the banks in late-2011 and mid-2012. They had horribly underperformed the market and investors were worried about bad debt levels… we all know how that's turned around since.
Monadelphous
Monadelphous Group Limited (ASX: MND) in this case represents the best house in the worst street (engineering companies). Unlike some peers, Monadelphous has a huge net cash balance of nearly $240 million. This is expected to be used for smart acquisitions going forward.
Last financial year the group secured a prized $680 million contract at the Ichthys LNG Project but has since struggled to win similar sized projects. Two smaller wins will help but analysts expect the contracting environment to be very weak going forward.
The most important thing for me is the knowledge that Monadelphous has been through this before. The company has been around since 1972 and has an extremely capable and experienced management team, but investors will have to be patient.
Earnings will fall in coming years, but with costs being cut and smaller projects helping to sustain revenues, most analysts expect the company to continue paying out a large proportion of slowly-declining earnings as dividends. The company is trading on a forward dividend yield of over 7%, fully franked, and a price to earnings ratio of just 11. These are attractive numbers for long-term investors!
