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Why Royal Dutch Shell Plc Profit Forecasts Have Fallen Hard

Analysts at investment banks are paid megabucks to research top companies. These are some of the most intelligent and well-qualified people operating in the financial services industry. So, when they all move to downgrade profit expectations for a particular company, investors should try and discover why.

Falling forecasts and a low share price

In the last year, earnings estimates for Shell have been declining. At the beginning of last year, expectations were for $4.50 of earnings per share (EPS). Six months ago, that figure had fallen to $4.28. Today, it is $3.92.

This matters. Market confidence in a company’s future profitability is a key part of the rating that investors will award the shares. Earnings downgrades undermine confidence in future earnings. Investors will ascribe greater risk to the company and will demand a bigger discount before buying.

There is some evidence that this is weighing on Shell’s shares. One year ago, the shares traded around 2,300p. Today, they are 2,145p, within a whisker of their low for the year of 2,098p.

Reasons for the forecast fall

Shell released its results for the half year at the beginning of August. Management bemoaned higher costs, unfavourable currency movements and increased strife in Nigeria for a big decline in profits. By one key measure, Shell made 21% less in the first half of 2013 than it did the year before.

Valuation

If Shell meets its 2013 forecast, then the shares are trading at 8.6 times full-year profits. Last year, Shell paid out $1.72 of dividends. This is expected to be increased this year to $1.86. That’s a dividend yield of 5.5% for the year.

Both profits and dividends are expected to grow in 2014. This lowers the P/E on the shares to 8.3, with the prospect of a very chunky 5.7% yield.

Verdict

Do not forget that Shell has historically been one of the most reliable companies on the market. Although the deterioration in Shell’s prospects for the year is concerning, compared with the average FTSE 100 company, the shares are cheap. If Shell can get back on track in 2014, anyone that didn’t buy this year could be left kicking themselves.

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> David does not own shares in any of the companies mentioned.