One Big and One Small Stock To Buy Today

It has been a tough 12 months for stock market investors, but we firmly believe there are some excellent value stocks you can buy today.

Below we highlight the one and only banking stock we like today, plus a selection of some of our very favourite resource stocks, including one BIG one and one SMALL one to BUY today…

Dear Battered and Bruised Stock Market Investor,

The 2007/08 tax year is almost at an end.

For stock market investors, it’s been a shocker, with the All Ordinaries Index slumping a wealth destructing 14% over the past 12 months.

But we have got two reasons to smile …

1. The resources sector continues to run red-hot, with iron ore prices up 85%, the oil price still hovering near record highs, and predictions Australia’s commodity exports will grow by another 40% next financial year. It all bodes well for our specially selected resource stocks.

2. Because of (justified) jitters about the state of the global economy, specifically the US and the spectre of rising inflation, the stock market has been falling, dragging the price of many resource stocks down with it. That gives us the opportunity to pick up some specially selected resource stocks at cheaper prices than they were just a few short weeks ago.

The Super Dream Gone Wrong

A year ago, with the stock market riding high, the Howard Liberal government’s superannuation reforms encouraged thousands of ordinary Australians to tip billions of additional dollars into super funds.

Investment properties were sold and the cash added to super funds. Financial advisors and planners were working over-time. Some people even borrowed money in order to maximise the amounts they could put into super.

It was almost entirely done in the name of tax. Superannuation is an excellent tax-efficient way of saving for your retirement.

But what many ordinary Australians failed to even consider was that the stock market can go down as well as up.

For years, we’ve been spoilt. We’ve been used to consistent double digit capital returns from the stock market, plus impressive dividend returns. You had to go all the way back to 2002 to find the last calendar in which the Australian stock market fell. Before that, it last fell in 1994.

Put another way, since 1994, the stock market as measured by the All Ordinaries Index, has fallen in only one calendar year.

Faster Than A Brett Lee Thunderbolt

That’s one down year in 13 years.

One of the mistakes many investors make is assuming the near-term past will be replicated in the long-term future.

So…up until November 2007, because the stock market had been rising strongly for many years, financial advisors, investment bankers, private investors, mums, dads, bar staff and taxi drivers simply assumed it would carry on doing so in 2008, 2009, 2010 and for every year ahead.

Welcome to reality.

In the short-term, the stock market is not a one-way bet. Many factors influence its short-term direction, and these can and do change almost on a daily basis.

Economic data is released faster than a Brett Lee thunderbolt. One piece of data is often in direct conflict with another piece of data. One person will interpret the data one way, another person will interpret it an entirely different and opposing way.

Often there are more questions than answers. For example, at the moment we have…

Question #1 : How High Can The Oil Go?

The oil price continues to dominate the news. We have OPEC saying the high price of oil is all due to hedge funds and financial speculators.

On the other hand, we have governments around the world, including our own here in Australia, telling OPEC the high oil price is because demand is exceeding supply, so please Saudi Arabia, pretty please Saudi Arabia with sugar on top, can you please please please pump some more oil?

Please Pump More Oil

It will bring down petrol prices for our gas guzzling western economy voters, help us ease inflation, and help get our greedy economies back on the straight and narrow. Please pump more oil.

There is a strong “global warming” argument that the oil price should remain around where it is now. Slowly but surely the high petrol prices are starting to change our behaviour – we are driving less miles and kilometres, we are dumping petrol guzzling V8s for fuel efficient smaller cars, airlines are cutting capacity, we are increasingly thinking about switching to hybrid cars and more bicycle lanes are being built.

And that’s not all that can be done to reduce our utter reliance on petrol – try things like car pooling, walking and cycling to work and school, working from home, and leaving the car at home and taking public transport, just to name a few.

Anyway…what does the high oil price all mean to us as stock market investors?

• On the one hand, we have some commentators predicting the oil price is in a bubble and is set to fall back from its current US$135 odd a barrel back to US$100 a barrel over the next few months.

• On the other hand, some people are predicting the oil price is only headed higher, both in the short-term and in the long-term.

• But a higher oil price will unleash even higher inflationary pressures. Inflation is the economy’s public enemy number 1, and will be fought with higher interest rates, which in turn, by definition, slow the economy. We’re staring at a classic catch-22 situation.

We told you there were more questions than answers.

We Got This One Wrong…But It’s Still A Winning Bet

We aim to answer the questions. We don’t get every answer exactly right.

For example, at the beginning of 2008, we said we remained bullish on oil. But we didn’t remain bullish enough, setting our 2008 oil price target at US$90 a barrel.

So…one point for a right answer and minus one point for a wrong answer.

But in this game – the game of long-term stock market investing – you can get unlimited points for a right answer but only lose one point for a wrong answer. That’s because shares prices can go up thousands of percentage points, but can ‘only’ go down 100%.

Whilst the oil price has risen substantially above our short-term target of US$90 a barrel, we haven’t been recommending our Members sell any oil company shares. On the contrary, we’ve been recommending they BUY shares in some of our specially selected favourite oil companies.

Oil Set To Hit US$200 A Barrel

At the same time, we’ve modified our thoughts on the oil price, saying…

• We believe triple-digit oil prices are here to stay.

• We believe oil could easily trade as high as US$200 per barrel.

When it comes to the high oil price, we firmly believe in the “demand exceeding supply” argument rather than it being driven by financial speculators.

Take these facts…

- Oil is a naturally depleting commodity.

- The last major oil discoveries occurred in the late 1970s and early 1980s.

- Almost all of the world’s cheap and accessible oil has already been discovered.

- The world currently has around 6.7 billion people, many of whom are utterly reliant on oil. The world population is expected to reach nearly 9 billion people by the year 2042.

- The current alternatives to oil are either unproven, very expensive or impractical.

So there you have it. Over the long-term, we believe the oil price will rise inexorably higher, not withstanding the odd hiccup.

Fight Them Not On The Bowsers, Beat Them On The Stock Market

As we’ve said many times before, the way to fight higher petrol prices is to buy some specially selected oil stocks.

Our preference has always been for smaller oil companies.

In fact, right now we think we’ve found a collection of smaller oil companies who generally have similar characteristics, being…

- The fly largely under the radar of the large institutional investors, meaning the shares are relatively cheap.

- They have outstanding leadership teams, many of whom we have personally met, and all of whom have extensive oil company experience, often in much bigger companies.

- They are already profitable oil producers, mostly with little or no debt.

- They have outstanding exploration prospects.

In a nutshell, at today’s prices, we believe many of these smaller oil companies are fairly valued based on their current production and profits, with the option of significant exploration success thrown in for free.

It’s our oil-stock version of investing with a large margin of safety.

Question #2: Is This A Resources Bubble?

We’ll let you work out the answer to this one yourself…

• Macarthur Coal went into a trading halt earlier this week as foreign suitors continued to circle the business. The shares were suspended at $20.73, at which price they trade on a price-to-earnings ratio of around 60 times – a quite astoundingly high valuation for a commodity business. There’s seemingly no shortage of steel producers willing to pay that high a price to secure Macarthur’s environmentally friendly PCI coal.

Do you think they see any end to the resources boom?

• After months of negotiation, Rio Tinto has just secured an iron ore price increase of 85% with Chinese steel-maker Baosteel.

Do you think Boasteel would be prepared to agree to such a massive increase if they could see any end in sight for the resources boom?

• The Australian Bureau of Agricultural and Resource Economics (ABARE) this week predicted the value of Australia’s total commodity exports is predicted to rise by 40% next financial year.

Does that sound like the end of the resources boom?

• There is a mini power crisis going on right now in Western Australia, following the explosion that took place recently at the Varanus Island gas hub, located in the North West Shelf region offshore Western Australia.

The facility is responsible for supplying some 30% of WA’s domestic gas needs. The government is encouraging people to turn lights off and to take four minute showers to save power.

It sounds to us like Western Australia needs to discover more gas, and preferably quite quickly, or else it won’t be just their two AFL teams who are left in the dark in 2008. What do you think?

As it happens, we are quite familiar with the North West Shelf area of Western Australia, principally because one of our favourite smaller oil and gas companies is currently drilling for gas in that exact area.

They are targeting a potentially lucrative discovery in the vicinity of 1 trillion cubic feet (TCF) of gas, which could more than double their existing petroleum reserve base.

Importantly any discovery could be brought into production quickly and cheaply.

Results from this potentially transformational well are due any day now. If they are positive, the share price of this smaller oil and gas company could literally take-off.

Question #3: Is It Time To Buy Aussie Banks?

We continue to be amazed at the fascination with banking stocks. We guess it comes down to a few points…

- Many people have become shareholders in banks courtesy of their privatisation over the past 20 odd years.

- Until very recently, bank shares have made for exceptional long-term investments.

- The Big Four Australian banks operate in a quasi cartel. Mortgage rates are remarkably similar, as are savings rates. This cosy togetherness has resulted in all four banks recording high and growing profits, much to the delight of the thousands of shareholders.

- Banks have been some of the highest dividend yielders on the market. Coupled with their collective dominant market position and therefore implied safety, they have become a firm favourite amongst self managed super funds and retirees in general.

- If you can’t beat them, join them. Rather than forlornly venting our frustration at the increasing number and increasing cost of the myriad of bank fees, people have instead bought shares in the banks.

- Private investors just love retailers and banks. They see them at their local shopping centre, and use them. They recognise the brand names. If their broker or financial advisor gave them a choice of buying shares in Commonwealth Bank or Terramin Resources, we suggest they’d plump for the bank. Why? They’ve heard of Commonwealth, but not Terramin. Strange but true.

We continue to avoid most banking shares. For us, it is not the time to be buying banks…

- The Australian economy is facing some strong headwinds.

- Inflation remains annoyingly high.


- Unemployment is edging higher.

On top of all that, we believe house prices are soon to come under increasing pressure, with a material risk of a fall.

The Scary Truth About House Prices & Bank Shares

We don’t wish to scare you, but US house prices are already down around 16% from their peak.

Then just last week, HBOS, owner of BankWest and the United Kingdom’s biggest housing lender, forecast UK house prices would fall by 9% in 2008.

If you thought Australian banking shares were becoming cheap, and some of them having fallen by around 33% from their recent peak, shares in the UK’s HBOS are down a whopping 75% from their peak and now trade on a trailing price-to-earnings ratio (P/E) of just 2.5 times.

To put that into perspective, if Commonwealth Bank were to trade on a trailing P/E of 2.5 times, its share price would be $6.80, down from the $40 it trades around today and the $60 it traded at as recently as November last year.

That sort of share price carnage is not about to befall Commonwealth Bank or any of the other major Australian banks. But it is a stark reminder that banks are extremely profitable in times of economic prosperity, yet in times of rising mortgage defaults and falling house prices, profits can virtually disappear, as can share prices!

The One & Only Bank We Are Buying Today

As we said above, we continue to avoid most banking shares.

But not all of them.

Very recently, we re-recommended one of the Australian mid-tier banks as a BUY. The company trades on a forward P/E of around 9-10 times and a forward dividend yield of around 7-7.5%, or more than 10% on a grossed up basis.

In line with the rest of the banking sector, the shares are substantially off their recent high.

Yet recent times have seen positive sentiment returning to the share price. Added to that, in the light of the Westpac takeover for St George, we are of the opinion that this company could also become a takeover target.

All in all, this is the only bank we are happy to recommend as a BUY, and although we anticipate that several months of consolidation and base building will be required before a sustainable revival of upward share price momentum emerges, we are very confident in the long-term prospects of this particular bank.

Question #4: Is It Time To Buy Shares Now?

Good question.

Our general view is that time to buy is now. It is always now.

But there are two important catches…

Catch No 1: It’s only time to buy THE RIGHT SHARES now.

Catch No. 2: It’s only time to buy shares now if you are prepared to hold them for the long-term.

As we’ve said plenty of times before, we think the resources boom is set to last for years and even decades ahead. The unprecedented great Chinese urbanisation is only just beginning. China has one of the lowest urban-to-rural ratios in the world, yet have the largest population in the world.

We could go on, but we think you get the message – we are firmly of the opinion that resources stocks still offer share market investors the best prospect of long-term capital gains.

We’re not all talk either – one look at our hypothetical portfolios show they are packed with our very favourite resources stocks.

We have big ones and small ones. Low risk ones and higher risk/higher reward ones. We have gold ones. We have oil ones. We have zinc ones. We have uranium ones. We have iron ore ones. Silver ones. Copper ones. Coal. Gas, and more.

For example…

BUY This Big One

Just last week we recommended this large diversified miner as a BUY.

The company has recently announced it is merging with another large Australian miner. We believe this ‘de-risks’ the company and sets the foundation for the combined entity to become a significant force in the diversified mining sector.

Indeed, the company will be Australia’s third largest diversified miner behind Rio Tinto and BHP Billiton, and the fifth largest miner on the Australian Stock Exchange.

The combined company offers broad based exposure to our view of continued commodity price strength. And the best part about this large diversified miner is that it is cheap, trading on a single digit price to earnings ratio.

We concluded our buy report with “…we believe the stock will be re-rated as future earnings growth comes into view in the months ahead.”

BUY This Little Copper One

Also just last week, we recommended this small copper explorer as a BUY.

We have followed the steady progress the company has made on its African exploration projects for the past few years; however only now do we believe the time is right to recommend the shares as a BUY.

The company has a major ground position in Botswana and is aggressively pursuing development of its primary project, a large copper deposit. The company looks cheap compared to its copper sector peers, which has prompted our initial Buy recommendation.

The charts back up our buy recommendation – we believe the company offers considerable upside potential over the longer term. Despite periodic bouts of volatility, a firm upward trend has emerged since 2005 and we anticipate further gains in due course.

We concluded our buy report by saying the company “…combines an attractive portfolio of mineral assets in Africa that are at advanced stage of development. The company’s market value is modest, but the upside in our view is enormous, driven by its large ground position and the potential for more discoveries.”

We think there’s a good chance the ONE BIG ONE above and this ONE SMALL ONE pass our test of being the right shares to buy now and to hold for the long-term.

We wish you happy and profitable long-term investing.

P.S. Remember the brand new Northern Territory iron ore producer we mentioned last week? At the time, the shares were around 77 cents. This week the shares closed Monday at just 64 cents. But that was before Rio Tinto agreed its massive 84% iron ore price hike. It seems that woke up the stock market to this company again, as the shares soared an astounding 12.5% on Tuesday alone. Yet they are still trading below the 77 cents of just one week ago. We just love these types of compelling and profitable stock market opportunities.