Shell’s (LSE: SHEL) share price is up 25% from its 9 April one-year traded low of £22.70.
I believe that much of this increase came from the $3.5bn (£2.7bn)share buyback of Q2. That marked the 1th consecutive quarter in which it spent at least $3bn on such a programme. These operations tend to support share price gains.
The latest part of the share price rise followed the 30 October release of its Q3 results.
How were the numbers?
Adjusted earnings (Shell’s definition of net profit) reached $5.4bn, outperforming analysts’ consensus of $5.09bn. Cash flow from operations – which can be a major driver for growth in itself – came in at $12.2bn. Meanwhile, net debt fell by 4.6% from the previous quarter to $41.2bn.
The firm attributed these numbers to two key factors. First, a strong operational performance driven by record oil and gas production in Brazil and 20-year highs in the Gulf of Mexico. Second was higher liquefied natural gas (LNG) volumes in its Integrated Gas business and improved LNG trading results.
The oil and gas giant also launched another $3.5bn share buyback to be completed in the next three months.
It additionally announced a third interim dividend of 35.8 cents, bringing the total this year to 107.4 cents. This marks a 4% increase over the first nine months of last year.
Its current dividend yield is 3.7% compared to the present FTSE 100 average of 3.3%.
A price-to-value gap?
A share’s price is simply whatever the market is willing to pay at any given moment. But its value is different – it reflects the true worth of the underlying business’s fundamentals. This true worth can be expressed as a stock’s ‘fair value’.
All asset prices tend to converge to their fair value over time, in my experience. This includes several years as a senior investment back trader and decades later as a private investor.
Consequently, being able to accurately identify and quantify this price-value gap is crucial to making big long-term profits.
The best way by far that I have found of doing this is the discounted cash flow model.
This pinpoints the price at which any share should trade, based precisely on cash flow forecasts for the underlying business.
In Shell’s case, it shows the shares are 56% undervalued at their current price of £28.44.
Therefore, their fair value is £64.63.
My investment view
Ultimately, the key driver for any stock’s cash flow – and therefore its share price – is earnings growth.
A risk to Shell’s earnings is any significant and prolonged downturn in oil and gas prices.
That said, the consensus forecast of analysts is that Shell’s earnings will grow by 8.3% a year to end-2027.
I think this will continue to fuel its cash flow and allow its share price to keep converging towards its fair value.
Consequently, I will add to my existing holding in the stock very shortly.
