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Are Royal Dutch Shell Plc And BP plc Screaming Bargains As Prices Plunge?

As an investor, how often do you dream of being able to buy a top FTSE 100 company at a 52-week low, on a price that has slumped by 25% over the past 12 months? Well, if you glance at Royal Dutch Shell (LSE: RDSB)(NYSE: RDS-B.US), that’s exactly what’s on the table with the shares at 1,878p.

Over at BP (LSE: BP)(NYSE: BP.US), the shares are actually a little up since their low point in December last year, but we’re still looking at a 15% fall over 12 months and a definite downturn since mid-April.

Buy when others are fearful

One of the best things you can do as an investor is buy into long-term resilient sectors when they’re irrationally depressed — and when the whole market is dragged down by eurozone political worries, so much the better.

If you’d bought shares in the big banks in the depths of the financial crisis, you could be up 460% on Barclays today, or up 270% on bailed-out Lloyds Banking Group in less than four years.

And if you’d invested in the UK’s biggest housebuilders, well, you’re probably more likely to be sunning yourself on a beach somewhere than listening to me banging on about buying big oil shares — after all, if you’d bought Barratt Developments five years ago your investment would have nearly five-bagged today.

So what is it that makes our two big oil companies attractive right now? I’m no good at timing markets, but decades of experience have taught me that if you can get close to the point of maximum pessimism for a sector, you’ll do well. Was the point of maximum pessimism for oil stocks coincident with crude oil at less than $50 a barrel in January this year?

Now could be the time

No, it wasn’t, because many correctly saw that as unsustainably low because of the actual costs of extracting the stuff, and the world has since settled on a price range of $60-65 a barrel as a balance between demand and sustainable production. In the long term it’s anybody’s guess, but oil demand is actually still rising, and I can easily see a sustainable medium-term crude price of around $70-75 a barrel — much beyond that and fracking starts to look attractive again, and that would seriously mess with the demand/supply balance.

There’s obviously always a risk, and I’m definitely a bit twitchy about dividends right now. At Shell we have tasty yields of 6.5% forecast for this year and next, but that would be barely covered by 2015 earnings forecasts — cover would rise to 1.35 times a year later, but there’s still not much of a safety cushion there. At BP we’re looking at mooted yields of closer to 6%, with the 2016 payout expected to be covered only around 1.2 times.

Dividend cut?

Might there be a cut? There might indeed, but we’re still looking at 2016 P/E valuations of 11 for Shell and 13.5 for BP. Maximum pessimism? Can’t tell, but they’re both clearly in misery-guts territory to me.

Investing in big FTSE 100 oil companies has been a cornerstone of many a portfolio that has brought in great long-term rewards.

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