A frustrating aspect of investing is when external factors affect the financial performance and share price of a company in which an investment has been made.
That's because, while the business itself may be financially sound, have a great strategy and superb product, a slowdown in the economy or lack of demand for a specific good or service can cause a severe decline in its top and bottom lines.
For example, Rio Tinto Limited (ASX: RIO) appears to be doing all of the right things as a business. It has become ruthlessly efficient and reduced its cost curve even further to become one of the lowest in the global iron ore industry. In response to a lower iron ore price, Rio has increased production levels, heaping further pressure on its less efficient rivals and strengthen its own position on a relative basis.
However, Rio Tinto continues to struggle because the iron ore price is unbelievably low. It dropped to a ten-year low this year and, looking ahead, it would be unsurprising if it continued to disappoint over the medium term – especially since Chinese economic growth (and, therefore, demand for the steel-making ingredient) remains very uncertain.
Despite this, Rio Tinto remains a very worthwhile long term investment. It is extremely well-run, has a very strong balance sheet and has been able to increase its cash flow at an annualised rate of 10.1% in the last five years, thereby highlighting its financial strength. With the company yielding a fully franked 5.4% and being forecast to increase dividends by 5.8% per annum during the next two years, it seems to be a great income play for the long term.
Similarly, Woolworths Limited (ASX: WOW) has also been hit hard by external factors; namely the economic challenges facing Australia at the present time. This has caused shoppers to begin to seek out lower priced items and cut back on spending wherever possible, with grocery shopping being an obvious candidate. And, with the growth in store numbers of no-frills operators, Woolworths has faced increased competition and changing customer tastes at the same time.
Clearly, it is going to take a prolonged period for Woolworths to successfully execute a turnaround and, with its bottom line expected to fall by 7.5% per annum over the next two years, this may appear to be the wrong time to buy it. However, with market sentiment having the potential to pick up under a refreshed strategy by the new CEO, Woolworths' price to sales (P/S) ratio of 0.51 indicates that, while volatile, it looks set to be a profitable investment in the long run.
Similarly, shopping centre operator, Scentre Group Ltd (ASX: SCG), is also likely to be hurt by weak consumer confidence. This could cause the profitability of its tenants to come under pressure, thereby making empty stores much more likely and rent increases less generous over the medium to long term.
However, Scentre Group still has huge appeal – especially since the impact of interest rate cuts could be significant on attitudes towards spending. Furthermore, Scentre Group offers a yield of 5.5% and trades on a price to book (P/B) ratio of just 1.23 which, for a company with enviable sites across Australia and New Zealand, appears to be good value while the ASX has a similar P/B ratio.
