For many investors, popular stocks equate to good stocks. In other words, if a company's shares have performed well in recent months or years and the investment world is upbeat about their future prospects, then it is a strong buy signal. And, while such stocks can deliver some impressive investment returns, often their future potential is already priced in.
Therefore, it can make sense to take a contrarian view and pick out companies that have failed to get investors' pulses racing. This does not necessarily mean they have posted massive share price declines, but are perhaps underperforming for one reason or another.
Two companies that fall into such a bracket are Rio Tinto Limited (ASX: RIO) and Commonwealth Bank of Australia (ASX: CBA). They have both failed to match the ASX's 4% rise since the turn of the year, with them being down 8% and up 2% respectively since the turn of the year.
In Rio Tinto's case, this level of underperformance is to be expected, since with around 90% of its profit being derived from the sale of iron ore, the collapse in the commodity's price level has caused sales and profitability to contract sharply. And, while Rio Tinto is an efficient business with a relatively low cost curve, even it has felt the effect of an iron ore price slump. In fact, its profit in financial year 2015 is expected to be less than half of its financial year 2014 profit level despite Rio Tinto having bolstered production.
Meanwhile, CBA has failed to sufficiently excite investors so as to outperform the wider index despite posting a rise in earnings of 12% last year. And, while forecast annualised growth of less than 5% over the next two years is hardly stunning, CBA has the greatest exposure to the housing market among Aussie banks. With interest rates likely to move further downwards in 2015 and 2016, its profitability could gain a boost and help to positively catalyse investor sentiment.
Certainly, neither CBA nor Rio Tinto are particularly cheap based on their forward price to earnings (P/E) ratios of 15.9 and 15 respectively. However, their respective yields of 4.7% and 5.2% still hold great appeal as a consequence of a loose monetary policy environment – especially if low interest rates push inflation higher and cause cash balances to offer a negative real return.
In addition, both companies offer an excellent track record of dividend growth that should provide investors seeking a strong yield with confidence regarding future dividend increases. For example, Rio Tinto has increased dividends per share at an annualised rate of 39% during the last five years, with the figure being a still impressive 12% per annum for CBA. Looking ahead, dividends are set to rise by around 5% apiece in each of the next two financial years, which is over three times the current rate of inflation.
However, their main appeal in the long run may be more to do with size and scale rather than anything else. In other words, they are the dominant stocks in their respective fields and, therefore, may be able to better survive an uncertain period than their smaller, less financially sound peers. This advantage could be worth a lot more to investors in future than it has in the past, particularly with the Aussie economy experiencing an uncertain future.
