Many people on here expect their brokers to know the future and be able to provide perfect advice, only to become bitter when that impossible expectation doesn't materialise - the problem isn't with their "broker".
The nuts & bolts of analysts research is:
- An expectation that at some point in the near future, iron ore prices will peak (may have already occurred) and will decline back to a long-term average, this view is well-grounded in industry economics (the cost curve). Whilst there is a lot of debate about when this may occur, it's not really material to FMG's valuation.
- The current high dividend yield and low PE is not expected to be maintained in the future.
- The material aspect is at what level iron ore prices fall back to, and this is why broker targets range from $18 to $30, even a $5 increase in the long-term iron ore price assumption makes a big difference to FMG's valuation.
So I think an investor needs to be prepared for:
- Based on broker research, there needs to be an expectation that this is "top of the cycle" and you are more likely to wake up to a declining iron ore price and negative sentiment for quite some time.
- If brokers are wrong, then FMG is very much undervalued and will continue to pay big dividends.
Here's an example (not advice) as to how the pro's/con's could be used:
- Let's say Iron Ore remains where it is an FMG pays $5 in dividends next year, which will come with ~$2.14 in franking credits which is a 9% return on its own - options and structure products are not priced for franking credits.
- So someone could say buy X of FMG and maybe place a hedge via a synthetic short using options against a fraction of the stock purchased (like 30% etc) - this will effectively neutralise the gain/loss on the proportion of X that is hedged, but:
- If FMG goes up (brokers not right), full gains and dividend income will be made on the unhedged portion AND the franking credits, less some slippage will be harvested on the hedged proportion.
- If FMG goes down (brokers right), the hedge will help offset the loss AND still harvest some franking credits.
That only works if you get the franking credits back as an actual return.
Otherwise, things like a covered call strategy can be used to hedge both sides of the argument.
In short, I would prefer to buy FMG when iron ore prices are near "cost" and the share price trades at a high PE and low dividend as it is all upside from there. At the moment there is downside and thinking about ways the buffer that downside could be useful.
(20min delay)