Among my stock market investments this year, those that have stood out are the FTSE 100 oil biggies BP (LSE: BP) and Royal Dutch Shell (LSE: RDSB). No points for guessing why. Oil stocks are classic cyclicals. Such stocks are those where demand is sensitive to where we are in the economic cycle. So when the economy is in doldrums, as we saw in 2020, the oil price crashes. And during times of recovery, it picks up. This time around, perhaps even more so. The economic slowdown associated with the pandemic also brought all travel to a halt. As a result, there was a big impact on these stocks. It was natural then, that as the recovery ensued, oil prices rallied and along with that, these stocks’ prices.
More upside to come?
I do not think that we have seen all the upside to these stocks that we are going to. Think about this. We are still under the cloud of the pandemic. Travel remains restricted and consumers are being cautious too. Once these trends are behind us, I think we could see even higher oil demand. Also, continuing economic recovery will increase oil demand. This could further boost both BP and Shell’s financial performance.
Their improved finances could, in turn, result in higher dividends. These stocks boasted fairly high dividend yields pre-pandemic. But at present, they are nowhere near the highest dividend-payers. BP’s current dividend yield is 4.7% and Shell’s is 3.7%. These are not bad and are higher than the FTSE 100 average yield of 3.5%. But they are far from the 10%+ levels seen for the highest yielders. However, I am optimistic that their yields could rise.
Moreover, these stocks offer me a nice hedge against inflation. The UK’s inflation is on a tear and is expected to remain so through next year. Many FTSE 100 and FTSE 250 stocks could be impacted by this as their costs increase. But the oil giants are on the right side of inflation. They are actually beneficiaries from it. So, even if other stocks in my portfolio suffer, these can offer a stabilising impact.
What I’d do now
The big risk to oil stocks is another lockdown in 2022. If another variant of coronavirus emerges, who knows what could happen next? And if the last two years have taught us anything, it is to expect the unexpected. But I have to make my investment decisions based on the most predictable outcomes that I can see, and not on outlier events. Based on these, both oil stocks look quite good to me for at least the foreseeable future. Considering that their share prices are still below pre-pandemic levels, I think I am going to add to my holdings of these stocks in early 2022.
