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3-Point Checklist: Should You Buy Royal Dutch Shell Plc Or BP plc?

Over the last twelve months, FTSE 100 oil giants Royal Dutch Shell (LSE: RDSB) (NYSE: RDS-B.US) and BP (LSE: BP) (NYSE: BP.US) have matched each other’s performance exactly, with shares in both firms falling by 8%.

Oil and gas remain the most important sources of energy globally, and I reckon that most investors need some exposure to oil in their portfolios — so which stock is the better buy today?

1. Cheap oil?

The collapse in oil prices has resulted in widespread earnings downgrades for oil companies, but BP and Shell have not been affected equally, as these P/E figures show:

 

Shell

BP

2014 historic P/E

8.7

9.7

2015 forecast P/E

12.3

18.3

2016 forecast P/E

10.2

12.1

The latest consensus forecasts suggest that BP’s adjusted earnings per share will fall by 50% this year, before climbing by a similar amount in 2015.

The outlook for Shell appears to be more stable: earnings per share are expected to rise by around 20% in both 2015 and 2016, perhaps highlighting the benefits of the firm’s long-term focus on gas and LNG.

On a 1-2 year outlook, BP looks more expensive than Shell.

2. Profitability

Valuation is important, but so are the returns a company generates from its assets.

Two key measures of profitability are operating margin and return on capital employed (ROCE):

 

Shell

BP

5-year average operating margin

7.3%

1.7%

5-year average ROCE

13.1%

3.1%

Shell has clearly been the more profitable firm over the last five years.

This is partly because the Gulf of Mexico disaster has forced BP to sell nearly $50bn of assets and reduce the size of its operations, but it’s hard to ignore: Shell is more profitable.

3. Dividend yield

Most investors hold shares in BP and Shell for the reliable dividend income they provide.

Here are the current yields offered by both firms:

 

Shell

BP

2014 dividend yield

6.1%

6.1%

2015 prospective yield

6.3%

6.3%

Both firms offer similar yields, but are they equally safe? A yield of more than 6% is often a warning sign of a potentially unsustainable payout.

Dividend cover by earnings is certainly expected to be tight this year, remaining unchanged at 1.3 times at Shell, and falling to just 0.9 times at BP.

This situation is expected to improve in 2016, but given the extra pressure on BP’s finances from its US legal woes, I’d have to say that Shell’s dividend currently looks safer.

Which one should you buy?

In today’s market, I believe Shell is a more attractive buy for income investors, but both companies should perform well over the longer term.

However, if you already own shares in BP or Shell, I’d suggest leaving them untouched and looking elsewhere for new buying opportunities.

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Roland Head owns share in Royal Dutch Shell. 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.