The UK’s leading stock index, the FTSE 100 is full of high-quality blue-chip stocks investors can count on to produce a steady positive performance over the long term. However, these shares tend to trade at premium valuation multiples as investors are willing to pay for the extra security.
Occasionally, such stocks do fall out of favour with the market, and when this occurs investors are offered an opportunity to snap up the shares at an attractive valuation. You have to be quick, as these valuation discrepancies don’t last for long.
Discount oil
Royal Dutch Shell (LSE: RDSB) is one such opportunity. When the price of oil started to collapse back in 2014, shares in Shell plunged in line with the price of the commodity. Nearly three years on and the shares are still trading below their post-crash peak, but this may not continue to be the case for much longer.
Shell has proved over the past 12 months that it has what it takes to be able to survive the low oil price environment. Even though the price of Brent crude languished below $55 a barrel for the majority of 2016, Shell reported a profit for the year of $3.5bn on a current cost of supplies basis, a standard industry measure of profitability.
As well as multibillion-dollar profit, Shell shed $5bn of unwanted assets to pay down debt. And during the final months of the year, the company generated $9bn of cash after it succeeded in slashing underlying costs $10bn below the level they were before Shell and BG Group combined two years ago.
All in all, including exploration costs, which are expected to come in at below $27bn in 2017, and Shell’s dividend to investors, the company shed more than $4bn from its debt pile during 2016. These numbers show that Shell can operate very well in the current environment. Heading into 2017, the price of oil is more than 25% higher than it was at this time last year.
With this being the case, I’m expecting Shell’s financial position to improve even more during 2017. I don’t expect it will be long before the market wakes up to this fact. It could only be a matter of weeks before share price gains drag down the company’s current 6.6% dividend yield to a level more in line with the market average of 3.5%.
Insurance champion
Along with Shell, Admiral (LSE: ADM) looks to me to be another top stock that’s currently too cheap to pass up. Shares in Admiral are trading at a forward P/E of 16.8, which may seem expensive at first glance but Admiral is a long-term growth story. Over the next three years, City analysts expect the group to increase pre-tax profits by around 30%. Further growth could be on the cards if the company’s international operations report maiden profitability.
Admiral’s steady growth is complemented by a 6.6% dividend yield. Such a combination of growth and income is usually tough to find so shares in the firm may be worth snapping up before the market catches on to this opportunity.
