One of the most successful styles of investing is value investing. It involves unearthing companies that offer brighter future prospects than the market currently anticipates, with their valuation not currently reflecting their growth potential.
The challenge with value investing, though, is assessing whether a company really is good value, or is actually cheap for a very good reason. In other words, a stock may have a low price to earnings (P/E) ratio of trade at or below net asset value, but it may be struggling to stay afloat or else be on the cusp of a period of severe under-performance.
The oil and gas sector currently features a number of cheap stocks. For long term investors who can accept a relatively high degree of volatility, there is an opportunity to benefit from this by picking stocks that offer strong long term performance whilst they’re at bargain-basement prices.
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For example, Shell (LSE: RDSB) has posted a fall in its share price of 22% since the turn of the year, with the result that it now trades on a P/E ratio of only 13.5. Furthermore, Shell has a price to book value (P/B) ratio of just 1.02, which indicates that its shares are very cheap and could be due an upward re-rating in future.
As well as being cheap, Shell’s shares also appear to offer good value for money. That’s because its prospects are relatively bright, mainly as a result of its current strategy, which seems set to bolster its bottom line. For example, Shell is utilising its competitive advantage over its rivals in terms of its sound financial standing, with the $70bn takeover of BG allowing it to increase the quality and size of its asset base while prices are distressed.
And, with the deal expected to deliver even greater synergies than previously planned — Shell recently increased the anticipated benefits to $3.5bn from $2.5bn — it could act as a major stimulus on the company’s financial outlook.
In addition, Shell appears to be taking prudent steps to ensure the efficient allocation of its resources. For example, it has pulled out of exploration in the Arctic and while this contributed to an $8bn writedown in its third quarter results the company is confident of achieving cost savings of $11bn in the current financial year, as it plans for a $60 per barrel oil price to last over the medium term.
Such major efficiencies and changes to its business model seem set to ensure that Shell retains its strong position relative to its sector peers and, in the long run, the current challenges facing the sector could work to the company’s advantage. That’s because Shell is a relatively low cost operator with a strong balance sheet, whereas many of its peers are not. As such, Shell could become an even more dominant player within the industry – especially if it engages in further M&A activity in 2016 and beyond.
So, while Shell is cheap, it appears to offer good value rather than being a value trap. With it remaining highly profitable despite the difficulties presented by a low oil price, Shell is expected to grow its earnings by 7% next year. Beyond that, with a sound strategy, further bottom line growth as well as share price growth seems to be on the cards.
