Most investors would take one look at the performance of Rio Tinto(LSE: RIO) and BHP Billiton(LSE: BLT) over the past 12 months and disregard the shares. Indeed, since the beginning of February last year, shares in Rio have slumped by 42% and shares in BHP have fallen by 56% -- excluding dividends.
However, while most investors might be afraid to touch Rio and BHP after recent declines, over the long-term these companies will make great additions to any portfolio.
A long-term bet
The key here is the long-term nature of BHP and Rio's operations, and investors need to approach these companies with that in mind. In the short term, it's unlikely that these firms will revolutionise your investment returns, or even generate a positive return. But BHP and Rio are built for the long term. It may be almost impossible to correctly time the market and buy one, or both of these mining giants just before an upswing. But over the long term, through a combination of both income and capital growth, BHP and Rio should help build your wealth.
So, why should every investor consider these mining giants?
Well, it all comes down to contrarian investing, or buying stocks that have fallen out of favour with the wider market. This strategy is hazardous but can produce some impressive returns if you get it right. BHP and Rio are two of the most contrarian plays around right now and because of their size, they make perfect contrarian bets.
BHP and Rio have some of the lowest production costs around, which will help them ride out the downturn in commodity prices. Further, the two miners have relatively stable balance sheets, which will, once again, help them ride out the slump.
These two industry giants have what it takes to ride out the trough while smaller, less efficient producers get pushed to the sidelines and struggle to compete. When these smaller producers start to collapse, BHP and Rio's profits will surge as supply dwindles and commodity prices recover.
Low production costs and strong balance sheets are essential because when it comes to contrarian investing, you need to know that the company you pick isn't going to go out of business anytime soon. Timing the market, or buying just before a stock rallies without having to ride out further declines, is an almost impossible task. When you invest as a contrarian, you need to concentrate on minimising potential losses before concentrating on the upside.
BHP and Rio should be perfectly capable of riding out the slump and when the commodity market returns to growth, shareholders should be richly rewarded. If BHP's shares return to their 2011 high, investors would see a capital gain of 260%, while Rio's shareholders would see an increase of 160% if its shares returned to the same level.
The bottom line
All in all, BHP and Rio are great contrarian investments. The risk of them going out of business is low while the potential upside is more than 100%.
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Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK has recommended Rio Tinto. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.