The FTSE 100 decline in recent months has been hugely disappointing. However, the oil and gas industry has experienced an even tougher period, with the Shell (LSE: RDSB) stock price falling by 20% since May.
Since there’s little sign that the oil price will deliver a sustained recovery in the coming months, there could be further pressure on the stock’s valuation. However, here’s why this could represent an opportunity for Foolish investors to capitalise on its long-term potential.
Margin of safety
Of course, not all shares have experienced declining performances in recent months. Reporting on Friday was global music and audio products company Focusrite (LSE: TUNE). It released a brief trading statement which showed that its performance in November has been strong, with the momentum seen in previous months continuing. As a result, its revenue for the financial year to date is now ahead of the same period last year.
With the Focusrite share price having gained 47% over the last year, it now has a valuation which suggests that it lacks a margin of safety. For example, it trades on a price-to-earnings (P/E) ratio of around 27. This indicates it may lack investment appeal, since it’s expected to post earnings growth of just 5% in the current financial year.
At a time when a number of other stocks are trading on low valuations, the company may prove to be relatively unappealing over the long term. As such, it could be a stock to avoid, based on its current valuation.
As mentioned, Shell’s near-term prospects could prove to be relatively challenging. The oil price has a volatile history, and this looks set to continue in the short run. It has already fallen by 38% since the start of October, and investors appear to be factoring in further risks for the industry. Demand may suffer from a rising US interest rate, as well as the prospect of further tariffs on imports, and this could see a wide range of energy sector stocks experiencing declining valuations.
As ever, falling share prices could present a buying opportunity for long-term investors. In the case of Shell, the company has one of the strongest balance sheets in the industry, while also enjoying greater diversity than many of its industry peers. Therefore, it could offer less risk than many sector rivals, while also having high return potential.
Its recent decline means that the stock now has a P/E ratio of around 11. This suggests it could offer a margin of safety versus its intrinsic value. Although there could be further falls ahead for its share price, in the long run the company could offer recovery potential. A dividend yield of 6.3%, which is covered 1.5 times by net profit, suggests its total returns could be higher than those of the FTSE 100 in the coming years.
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Peter Stephens owns shares of Royal Dutch Shell B. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.