Fortescue Metals Group Limited (ASX: FMG), Rio Tinto Limited (ASX: RIO) and BHP Billiton Limited (ASX: BHP) might look cheap using basic valuation techniques, such as price-earnings ratio (P/E ratio), dividend yield and price-book ratio (P/B ratio)…
| Dividend Yield | P/E ratio | P/B ratio | |
| BHP Billiton | 6.80% | 17x | 1.56x |
| Rio Tinto | 5.30% | 13x | 1.75x |
| Fortescue | 1.80% | 17x | 0.70x |
Source: Morningstar Inc.
…but they're not cheap in absolute terms.
Indeed, investors who use any of the above techniques to value a company's shares should be very careful.
Dividend yields, P/E and P/B ratios are static measures of value. Therefore, they lack theoretical robustness because they fail to take into consideration the future utility of a business.
As any seasoned value investor will tell you, to be successful in the sharemarket you'll need to dig deeper into financial statements and the industry in which a company operates. And let me tell you, it's not pretty.
Here's a chart I recently shared with readers, showing major commodity prices over the past 20 years.
As can be seen, compared to the past decade, current commodity prices are significantly depressed, and likely to stay that way for some time. Indeed, unless there is a meaningful step change in demand there is no reason to believe they won't return to the pre-resources boom levels of the early 2000's.
Some analysts will argue that due to their extremely low costs, none of the above companies will go bust in the current market conditions.
Sure, they won't go bust – I agree.
There's no reason to buy these three stocks today, especially given they may struggle in the coming three years and when there are another 2,000 stocks listed on the local market vying for your investment dollars.
Finally, think about this: All three companies' shares have produced a negative total return (dividends plus capital gains) over the past five years, when commodity prices were riding high, so why would they start performing better when prices are lower?
