Patience is one of the key attributes of a successful investor. The likes of US master Warren Buffett have been known to wait years for the right company at the right price.
Now, while buying stocks at a fair price will tend to pay off over the long term, we all love to bag a real bargain.
Today, I’m going to tell you why I believe FTSE 100 oil giant Royal Dutch Shell (LSE: RDSB) (NYSE: RDS-B.US) is currently in the bargain basement.
Pricing power
It’s generally the case that markets give companies that have “pricing power” — which typically results in strong profit margins — a higher earnings rating than those lacking this desirable quality.
Hence, we find firms such as British American Tobacco, premium-drinks group Diageo and household-brands champion Unilever trading on price-to-earnings (P/E) ratios well above the market average, while companies in industries with little or no pricing power are down at the low P/E end of the range.
Oil companies, such as Shell, fall into the latter category. While I would consider Unilever, for example, to be in the bargain basement at a P/E as high as the FTSE 100 long-term average of 14, my bargain value for Shell is considerably lower.
At what price a bargain?
I do a regular quarterly review of the Footsie’s industry heavyweights for Motley Fool readers. The table below shows Shell’s share price and 12-month forecast P/E data over the last two years.
| Date | Share price (p) | P/E |
|---|---|---|
| Current | 2,230 | 9.5 |
| Oct 2014 | 2,360 | 10.0 |
| Jul 2014 | 2,551 | 11.6 |
| Apr 2014 | 2,340 | 11.1 |
| Jan 2014 | 2,280 | 9.6 |
| Oct 2013 | 2,146 | 8.2 |
| Jul 2013 | 2,176 | 7.9 |
| Apr 2013 | 2,185 | 8.0 |
| Jan 2013 | 2,197 | 8.0 |
As you can see, Shell’s P/E has varied a fair bit — from a low of 7.9 to a high of 11.6 — but has been well below the FTSE 100’s long-term average throughout.
My bargain-basement rule of thumb for a mega-cap company in an industry with weak pricing power is a P/E in single figures. So, on this score, Shell currently makes the grade — albeit not by as big a margin as we’ve seen on occasions in the past.
Because income typically represents a sizeable chunk of shareholder returns from these companies, I also use dividend yield as a double-check marker of value. My rule of thumb here is a 12-month forecast yield of at least a third above the market average. On this score, too, Shell sits within the bargain basement on a yield of 5.3%.
As analyst forecasts currently stand, and applying my P/E and yield yardsticks, I’d rate Shell as a bargain buy up to a price of about 2,300p.
