Investing in resource companies is, from my experience, inherently risky.
Indeed, their share prices seem to be continuously volatile and their performance as a business (in terms of profitability) can also fluctuate wildly.
For instance, if they are an exploration company and are successful then it is boom time for shareholders, while disappointment in the form of less resource than anticipated can mean an uncomfortable ride for all involved.
That’s why diversification seems to be crucial when investing in the resource sector. One way of achieving relatively high levels of diversification without buying a large number of companies is to invest in a mega-cap like Shell (LSE: RDSB) (NYSE: RDS.B.US).
It operates in a range of regions and has substantial oil and gas assets. Therefore, its profitability is far more stable than many of its sector peers, which should provide a more comfortable life for shareholders.
However, the big attraction of Shell seems to be the potential upside that it currently offers.
Indeed, Shell trades on a price-to-earnings growth (PEG) ratio of just 0.82. This is significantly below the PEG ratio ‘sweet spot’ of 1.0 and highlights just how cheap shares in Shell have become, with the sector as a whole remaining relatively unpopular among investors.
Certainly, Shell’s price-to-earnings (P/E) ratio is low at 9, but it also offers excellent growth prospects, with earnings per share (EPS) forecast to increase by 11% in 2014 alone.
This means that if Shell were to trade at the PEG ‘sweet spot’ of 1.0, its shares would reach a price of 2,700p each. This would represent a capital gain of over 22% from the current share price of 2,200p and, with Shell continuing to offer an above-average yield of 5.3%, a total return of nearer 30% seems to be achievable.
Furthermore, Shell’s cash flow continues to be extremely strong (it is, after all, a mature business operating in a mature sector). So, shareholders should also benefit from a vast share buyback, in addition to the enticing yield and considerable capital gain prospects. Indeed, 2014 has the potential to be a great year for investors in Shell.
