Over the past few months, investors have been chasing Shell (LSE:SHEL) shares higher. Up 28% in just the past three months, the Shell share price now sits at the highest level in over a decade.
Yet when looking at the outlook, some might be of the opinion that buying now’s a big gamble. Here’s why.
Warning signs
To begin with, a lot of the good news may already be factored into the current share price. The stock’s had a strong recent run, helped by rising oil prices and geopolitical tensions. But history tells us energy stocks can be very cyclical. When sentiment’s strong and oil prices are elevated, that’s often when expectations are already high.
Ultimately, it leaves less room for further gains because investors are already projecting the best-case scenario. Further, the oil price is a double-edged sword. Yes, the surge above $100 per bbl will help boost profits. But if prices spike too far, they can damage the global economy.
We know from the past that major oil shocks can trigger a recession, which would eventually hurt demand for energy and Shell’s earnings.
Finally, last month the business posted the latest quarterly results, and they weren’t flawless. Adjusted earnings fell from $5.4bn to $3.3bn this time around. For perspective, that was the weakest quarterly profit in nearly five years. It was blamed on a host of factors, including “lower marketing margins, lower realised prices and higher operating expenses”.
Taking a step back
When I consider all of those factors together, I do think it’s a big gamble to buy the stock right now. Don’t get me wrong, if it were trading near 52-week lows, given the weaker earnings and geopolitical uncertainty, it could be considered a good value pick. But with the share price at record highs, I feel it’s disconnected from what’s going on at the company.
Of course, some would disagree with me. If the conflict in the Middle East starts to de-escalate but oil still remains elevated, Shell could benefit from avoiding a global recession, but also enjoy the proceeds of high oil revenue. This could materially boost profitability.
Shell still generates huge amounts of cash. Even with the recent softer earnings, it produced tens of billions in operating cash flow and continues to return large amounts to shareholders through dividends and buybacks. This could interest income investors, with the divdiend yield at 3.11%.
Better options elsewhere
I think the risk relative to the potential reward of buying Shell shares right now doesn’t stack up. For exposure to the oil sector, there are more attractively valued stocks in the FTSE 100 and FTSE 250 for investors to consider. The same applies to people looking for dividend shares. On that basis, I’m staying away from Shell at the moment.
