Royal Dutch Shell Plc Could Be On The Cusp Of 20% Returns
It may seem difficult to believe, but shares in Shell(LSE: RDSB) are down by just 1% in 2016. That's despite all the fear surrounding the oil price and the global economy that has sent the FTSE 100 spiralling downwards by over 8%. As such, it could be argued that Shell's share price has held up remarkably well given the challenging trading conditions, as well as the high level of fear among investors in recent weeks.
When it comes to the oil price, of course, all bets are off. It's nigh on impossible to determine when or if the price of black gold will rise. Therefore, companies such as Shell must make the best of a difficult situation and on this front, Shell appears to be doing just that. A notable example of this is its purchase of BG, which is set to strengthen the company's asset base, increase its profitability and also provide a higher degree of diversity moving forward.
In addition, Shell is in the process of improving its efficiencies and reducing its spending yet further. For example, it has reduced exploration spend and is also cutting staff numbers as it seeks to remain competitive on costs compared to its rivals. This should provide a high degree of sustainability and Shell is likely to be able to survive for longer than most oil and gas plays during a depressed market. This should mean that Shell warrants a premium valuation to most of its competitors.
However, Shell continues to trade on an extremely inviting valuation. For example, it has a price-to-earnings (P/E) ratio of just 11.9 and with the FTSE 100's P/E ratio being closer to 13, there's clear upside potential for Shell over the medium term. In fact, if its shares were to trade 20% higher it would still have a P/E ratio of only 14.3. Given its dominant position within the oil and gas sector and its aforementioned resilience during difficult periods for the industry, this seems to be a very fair price to pay.
Furthermore, with Shell forecast to increase its bottom line by 7% this year, its price-to-earnings growth (PEG) ratio of 1.7 indicates upside potential. And with its yield standing at 8.1%, this is further evidence that its shares are cheap. Although dividends could be cut due to affordability issues, Shell appears to have no plans to do so in the short-to-medium term. Even if they are cut, Shell is still likely to appear cheap based on its yield.
Clearly, buying an oil and gas company equates to high volatility in the short run. For long-term investors though, this is unlikely to be a major concern since often the best time to buy any stock is when its price is discounted due to fears surrounding global growth prospects. With Shell offering at least 20% upside and a generous yield in the meantime, it seems to be a great time to buy a slice of it for the coming years.
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Peter Stephens owns shares of Royal Dutch Shell . The Motley Fool UK has recommended Royal Dutch Shell B. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.