Sometimes, it makes sense to hold on to underperforming stocks. They may have posted a poor return because of external factors beyond their control, or the wider economy may be enduring a challenging period and be the cause of disappointing earnings growth.
However, other times it is better to leave a sinking ship for another vessel that has a better chance of staying afloat and, in the long run, of taking you to your chosen destination (i.e. a high total return).
This, then, is the dilemma currently facing investors in BHP Billiton Limited (ASX: BHP) and Woolworths Limited (ASX: WOW). Both companies are performing poorly and, as a result, have seen their share prices slump by 33% and 30% respectively during the last year.
In BHP's case, the cause of its downfall is a commodity price slump that seems to be never ending. For example, the iron ore price has hit a ten-year low this year, the oil price has fallen from over $100 per barrel to just $50 per barrel at the present time and, while BHP is a relatively well-diversified mining company, this has done little to aid it at a time when its key commodities have declined in price.
As a result, BHP's earnings are expected to fall from $1.55 on a per share basis in financial year 2015 to just $1 in the current financial year. That's a fall of 35% and would follow a similar fall from the previous year. Clearly, investor sentiment is unlikely to be anything but negative while such disappointing performance is being delivered.
However, BHP appears to be doing all of the right things to make a successful comeback. For example, it has increased production levels so as to try and increase its market share and exert even greater pressure on rivals with higher cost curves. It has also spun-off non-core assets in an attempt to improve efficiencies and add shareholder value, while a number of major capital projects have been postponed until such time as they become more economically appealing.
Furthermore, BHP's bottom line is forecast to rise to $1.40 on a per share basis next financial year, which would put it on a price to earnings growth (PEG) ratio of just 0.6. Therefore, while commodity prices may continue to disappoint, BHP appears to be worth buying at the present time – especially for investors who can live with above average volatility over a longer timeframe.
Meanwhile, Woolworths is also suffering from a challenging operating environment. The Aussie grocery sector appears to be undergoing a similar change to that experienced in the UK in recent years, where dominant players saw their market share being gradually eroded by low cost, no-frills operators. A key reason for that was an economy enduring a difficult period, with disposable incomes coming under pressure and shoppers therefore focusing to a greater extent on price. And, while the Aussie economy may perform much better than the UK's did, a supermarket price war and more competitive marketplace seems set to be a feature over the coming years.
Due to this, Woolworths is expected to post a fall in its bottom line of 7.4% per annum during the next two years. However, its shares trade on a forward price to earnings (P/E) ratio (using financial year 2017's forecast earnings) of 15.1 which, for a company that has increased its bottom line at an annualised rate of almost 9% during the last decade, seems reasonable. Furthermore, Woolworths offers a yield of 5.5% (fully franked), which is higher than the ASX's yield of 4.9% and, with dividends being covered 1.2 times even with the aforementioned profit fall being taken into account, it remains a top notch income play. As such, and like BHP Billiton, now appears to be the time to buy Woolworths, rather than sell it.
