Are Metals and Materials Stocks a Buy?

For most investors, maintaining a diversified portfolio is a good way to help minimize risk and sleep better at night while also making sure you don't miss out on winning sectors.

Diversification can mean many things -- small versus large stocks, dividends versus growth stocks, and so on -- but most often it's taken to mean spreading your bets among a variety of industries. Of course, just because you want to have some exposure to a variety of industries doesn't mean that you want to have the same amount of exposure to all industries.

So what of the materials sector? Should we be digging in or pulling back right now? Let's take a look.

Performance
Here's a look at how performance has broken down among the S&P 500 industries:

Sector

Month-to-Date Performance

Quarter-to-Date Performance

Year-to-Date Performance

Consumer Discretionary

(1.6%)

(3.1%)

6.6%

Industrials

(2.1%)

(8.1%)

3.3%

Financials

(2.1%)

(10.0%)

(0.2%)

Consumer Staples

(0.2%)

(6.4%)

(1.7%)

S&P 500 Overall

(1.7%)

(8.4%)

(4.0%)

Information Technology

(0.9%)

(7.5%)

(6.0%)

Health Care

(1.0%)

(11.6%)

(9.0%)

Materials

(3.1%)

(12.1%)

(10.0%)

Utilities

(2.3%)

(6.0%)

(10.3%)

Telecom Services

(0.8%)

(6.1%)

(11.4%)

Energy

(4.3%)

(11.8%)

(11.7%)

Source: Standard & Poor's as of June 1.

When it comes to metals and materials, the state of the global economy rules the day. If the economy is buzzing along there will be plenty of demand for metals like aluminum, steel, and copper; chemicals like fertilizers, pesticides, and industrial chemicals; and timber and construction materials. That not only pushes up sales volumes, but for the companies selling commodities, it also gooses sales prices.

And if we can believe the bold statement in a recent presentation from Brazil's Vale (NYSE: VALE  ) -- "The great recession is history. A manufacturing boom is under way supporting a strong demand for minerals and metals" -- then it may be worth shrugging off recent underperformance and taking a hard look at the companies in the materials sector.

Let's take a closer look
Here's a peek under the hood of some of the major U.S. materials stocks.

Company

Market Cap

Subsector

Trailing Return on Capital

Forward Price-to-Earnings Ratio

DuPont (NYSE: DD  )

$33 billion

Chemicals

12.1%

13.7

Freeport-McMoRan (NYSE: FCX  )

$32 billion

Metals and Mining

29.9%

8.7

Dow Chemical (NYSE: DOW  )

$31 billion

Chemicals

3.8%

16.0

Monsanto (NYSE: MON  )

$27 billion

Chemicals

13.2%

18.1

Newmont Mining (NYSE: NEM  )

$27 billion

Metals and Mining

14.1%

16.2

Source: Capital IQ, a Standard & Poor's company.

Though the sector as a whole is broadly driven by the direction of the economy, the companies involved still vary considerably.

DuPont and Dow provide a dizzying array of chemicals and other synthetic products, including agricultural pesticides, brake fluid, insulation, adhesives, display films, bulletproof vest material, and a heck of a lot in between. Monsanto joins these two in the chemicals segment, though it focuses primarily on agricultural products. While the economy has a lot to do with the performance of the chemical companies, the companies with greater exposure to noncommodity products -- like DuPont's Kevlar or Monsanto's genetically engineered seeds -- have better protection against economic crunches.

In the metals subsector of this group, most companies -- including copper giant Freeport-McMoRan and aluminum producer Alcoa -- live and die based on demand for metals as well as their operational efficiency. Expansion and building around the globe -- as we've seen in high-growth areas like China -- can be big boons for these companies. And though we could say that gold producers like Newmont are similarly driven by demand for the metal and operational efficiency, these companies depend on the gold market, which is largely driven by its own set of forces, including investors.

The often forgotten corner of the materials sector contains companies like Weyerhaeuser and Vulcan Materials in areas like paper and forest products, construction materials, and containers and packaging. As these companies largely provide commodity products, efficiency and solid management that's able to pilot their companies through the cyclical swings are crucial.

Though I've listed U.S. companies above, we don't want to ignore the global giants in this sector. Australia's BHP Billiton, Brazil's Vale, and the U.K.'s Rio Tinto are driven by similar forces as their U.S. counterparts, but dwarf them in size and offer significant diversity in the materials they mine.

Putting it all together
Currently, to be equal-weight to the S&P in materials stocks, you'd need roughly 3% to 4% of your portfolio in these names. That's a pretty low hurdle, and I think investors should have at least that much exposure.

But should you gobble up more of these material names? I think it depends a lot on how you approach your portfolio. If you like companies that are stable and relatively predictable, then being equal-weight should be just fine. The big chemical companies like Dow, DuPont, and Monsanto might be good picks, along with global giants like BHP and Vale.

For those that can handle a little less predictability, the economic recovery and growth in emerging markets may be a good reason to be overweight in the materials sector -- particularly when it comes to the miners. The voracious appetite that emerging markets have had for raw materials could mean big profits for the global mining giants, as well as fertilizer producers like PotashCorp (NYSE: POT  ) and steel producers like ArcelorMittal.

But be wary, the cyclical swings in these companies can be huge, and while a low price-to-earnings ratio can mean "cheap" in other sectors, it can just as easily mean "peaking" in this group.

Many investors think gold is a pretty exciting investment. Well, this stock may be even better than gold.

Monsanto and Vulcan Materials are Motley Fool Inside Value selections. Motley Fool Options has recommended a synthetic long position on Monsanto. Try any of our Foolish newsletters today, free for 30 days. The Motley Fool has a disclosure policy.

Fool contributor Matt Koppenheffer does not own shares of any of the companies mentioned. You can check out what Matt is keeping an eye on by visiting his CAPS portfolio, or you can follow Matt on Twitter @KoppTheFool or on his RSS feed. The Fool's disclosure policy assures you no Wookiees were harmed in the making of this article.


Read/Post Comments (3) | Recommend This Article (14)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On June 04, 2010, at 4:32 AM, ozzfan1317 wrote:

    NUE Is a 60 Dollar stock buy it and collect a solid dividend while the fearful become greedy.

  • Report this Comment On June 04, 2010, at 8:51 AM, radicalaccountin wrote:

    Before buying Monsanto, check out what they are doing with genetically modified seeds. Their practices are reprehensible.

    How about recommendations on best of breed metal stocks?

  • Report this Comment On June 15, 2010, at 11:05 PM, philkek wrote:

    Thanks MF for this article. Good information here to do further research on. Better Business Bureau recommends you investigate before you invest. I plan to do more homework on fundamentals before I invest in any of these items listed. NEM has made me some good gains. Must keep eyes and ears open for opportunities. Cash helps. Fool on.

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