At What Price Would Royal Dutch Shell Plc Be A Bargain Buy?

royal dutch shellPatience is one of the key attributes of a successful investor. The likes of US master Warren Buffett have been known to wait years for the right company at the right price.

Now, while buying stocks at a fair price will tend to pay off over the long term, we all love to bag a real bargain.

Today, I’m going to tell you why I believe FTSE 100 oil giant Royal Dutch Shell (LSE: RDSB) (NYSE: RDS-B.US) is currently in the bargain basement.

Pricing power

It’s generally the case that markets give companies that have “pricing power” — which typically results in strong profit margins — a higher earnings rating than those lacking this desirable quality.

Hence, we find firms such as British American Tobacco, premium-drinks group Diageo and household-brands champion Unilever trading on price-to-earnings (P/E) ratios well above the market average, while companies in industries with little or no pricing power are down at the low P/E end of the range.

Oil companies, such as Shell, fall into the latter category. While I would consider Unilever, for example, to be in the bargain basement at a P/E as high as the FTSE 100 long-term average of 14, my bargain value for Shell is considerably lower.

At what price a bargain?

I do a regular quarterly review of the Footsie’s industry heavyweights for Motley Fool readers. The table below shows Shell’s share price and 12-month forecast P/E data over the last two years.

Date Share price (p) P/E
Current 2,230 9.5
Oct 2014 2,360 10.0
Jul 2014 2,551 11.6
Apr 2014 2,340 11.1
Jan 2014 2,280 9.6
Oct 2013 2,146 8.2
Jul 2013 2,176 7.9
Apr 2013 2,185 8.0
Jan 2013 2,197 8.0

As you can see, Shell’s P/E has varied a fair bit — from a low of 7.9 to a high of 11.6 — but has been well below the FTSE 100’s long-term average throughout.

My bargain-basement rule of thumb for a mega-cap company in an industry with weak pricing power is a P/E in single figures. So, on this score, Shell currently makes the grade — albeit not by as big a margin as we’ve seen on occasions in the past.

Because income typically represents a sizeable chunk of shareholder returns from these companies, I also use dividend yield as a double-check marker of value. My rule of thumb here is a 12-month forecast yield of at least a third above the market average. On this score, too, Shell sits within the bargain basement on a yield of 5.3%.

As analyst forecasts currently stand, and applying my P/E and yield yardsticks, I’d rate Shell as a bargain buy up to a price of about 2,300p.

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G A Chester has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.