Blue chips are stocks that are considered more reliable than most of their peers. This could be because they operate in an industry that has been relatively stable in the past, or because they have an advantage over their peers, which makes their financial performance more consistent and robust than sector rivals.
With Shell’s (LSE: RDSB) share price having fallen by almost a third since its 2014 high and its bottom line forecast to decline by 35% in the current year, it appears at first glance as though Shell is not a blue-chip share. Yet despite this it still features as a core stock in a wide range of portfolios, with investors having historically viewed it as being a safe, secure and reliable investment for the long term.
Falling oil
Clearly, Shell’s disappointing financial and share price performance is largely due to the decline in the price of oil. The risk from a falling oil price has always been present and while investors are now acutely aware of the perils of buying shares in companies that are highly dependent on one specific external factor for their profitability, nothing has changed on this front for Shell. In other words, as an oil producer its profitability and share price performance have always depended on oil. The only difference is that in recent years investors had taken a high oil price for granted due to what was perceived to be an insatiable appetite for oil from the emerging world.
Certainly, demand for oil is forecast to rise in the coming years and the oil price is likely to recover as it becomes increasingly uneconomic to produce at less than $50 per barrel. However, this doesn’t alter the fact that Shell is still highly susceptible to a fall in the price of oil, which by definition makes it arguably less reliable than a utility, consumer goods company or other business that has greater diversity and isn’t reliant on the price of one commodity for its profitability.
Investment appeal
That’s not to say that Shell lacks appeal as an investment. It continues to have a superb asset base (which has been strengthened by the purchase of BG), has a very strong balance sheet with modest amounts of leverage and has a strategy set to deliver a rising bottom line over the medium term. Furthermore, it trades on a forward price-to-earnings (P/E) ratio of just 13.2, which indicates that it offers significant upside potential.
However, to be a blue chip, Shell must be more reliable than most other stocks. On this front, as the recent fall in the oil price has shown, Shell is arguably more susceptible to external factors than a number of its sector peers since the price of one commodity can quickly turn its bottom line towards negative growth. And while this has always been the case for resources stocks, perhaps moving forward investors will begin to factor this into valuations and demand a wider margin of safety when buying resources companies such as Shell.
