PotashCorp’s high valuation is encouraging, but comes with risks
Bored and not looking
Typically, investors are told to purchase companies with low valuations. For cyclical companies such as commodities, however, the best time to invest is during the worst time and when valuations are high because the majority of investors are pessimistic or bored. Note, investors should still make sure the company can weather the downturn and has a view that industry fundamentals will turn the corner soon.
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As the chart above shows, PotashCorp’s valuation has fluctuated quite dynamically in the past, ranging from as low as ~5.0 times to as high as ~30.0 times, based on forward price to earnings ratio. From the chart above, investors might notice three things.
- First, a large percent of movements in share prices are driven by multiples, rather than earnings.
- Second, divergences between valuation and share prices may sometimes foretell when trends are expected to change. For example, valuations didn’t hit their previous peak during the first quarter of 2008, while shares of PotashCorp continued higher, only to crash later. This also happened in the later part of 2013.
- Third, when valuations are high, share prices have usually performed well over the medium term.
Risks to be aware of
Still, investors should acknowledge certain risks. If the weather is more favorable later this year, and crop production comes in better than expected, potash producers such as PotashCorp (POT), Intrepid Potash, Inc. (IPI), Mosaic Company (MOS), and Sociedad Quimica y Minera de Chile (SQM) would be negatively affected (as pointed out in one of the previous articles). Furthermore, given that the market has been selling all the growth stocks and piling into defensive stocks, questioning whether they should be paying as much as they are, PotashCorp (POT) can still be negatively affected and valuations may still come down.
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