There has been plenty of trouble swirling around the machine in recent months — nay, years — to push shares across the banking and energy sectors steadily through the floor.
Financial colossus Lloyds (LSE: LLOY) and oil play Royal Dutch Shell (LSE: RDSB) fell to fresh multi-year lows during the start of 2016, although both shares have staged a remarkable bounceback more recently. Shell has risen 30% from January’s troughs, while Lloyds has gained 29% from the lows punched this month.
Paper titans
Despite these gains, however, it could be argued that from a ‘paper’ standpoint both companies remain extremely cheap. At Shell, a projected 30% earnings decline for 2016 may leave the business dealing on an elevated P/E rating of 21.6 times. A number of 15 times is broadly considered the benchmark for attractive value.
But a dividend yield of 7.9% — created by a forecast payout of 180 US cents per share, and obliterating the FTSE 100 average of around 3.5% — is sure to attract many a bargain hunter.
And while Lloyds may be expected to endure an 11% earnings fall this year, this results in a P/E rating of just 9.4 times. And like Shell, the bank also carries attractive estimates for dividend investors — a predicted 3.9p-per-share payout yields a chunky 5.4%.
But do these earnings and dividend figures make either firm a ‘buy’?
A brilliant banking choice
Well, in the case of Lloyds, the scale of PPI-related penalties is likely to remain a bugbear for investors.
The bank was forced to stash away an extra £2.1bn between October and December, and a rush of further claims are expected ahead of a possible 2018 deadline. Pre-tax profit dipped to £1.6bn last year from £1.8bn in 2014 as a result of these extra provisions.
However, Lloyds is pulling out all the stops to reduce its cost base, and the firm’s Simplification streamlining scheme is ahead of its target to generate total run-rate savings of £1bn by the close of 2017. And I believe the fruits of solid British economic growth should deliver robust earnings expansion at Lloyds beyond this year.
Meanwhile, dividend seekers will have been encouraged by Lloyds’ decision to return £2bn to shareholders last week in the form of dividends. This was facilitated by a steadily-improving CET1 ratio — this registered 13% as of December, up from 12.8% a year earlier — and further capital building suggests that investors can look forward to further generous payouts looking ahead.
Shell set to struggle?
Conversely, I do not believe that Shell warrants serious attention at current prices, however.
In certain cases stocks with huge earnings multiples can be justified, if they carry white-hot growth potential. But the huge supply imbalance washing over the oil market — and the consequent impact on ‘black gold’ values — is hardly conducive to robust earnings growth.
Markets are desperately waiting for co-ordinated output cuts from OPEC, the US and Russia in light of cooling global demand expansion. But yet an agreement is yet to be reached, heaping relentless pressure on already-heaving inventories.
In addition, Shell’s capex reduction plans and asset sales may be a wise decision in today’s capital-critical environment, but such measures hardly support the likelihood of a stellar earnings bounceback in the longer term.
And those expecting vast dividends could be in for a rude awakening, too. Predicted earnings of 111 cents per share are vastly overshadowed by the estimated dividend, while Shell’s recent purchase of BG Group leaves little-to-no balance sheet flexibility to meet current forecasts. I believe the crude colossus is a risk too far at the present time.
