The Motley Fool

What Could Go Badly Wrong With Royal Dutch Shell Plc & Rio Tinto plc At These Prices?

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

“I conceive that the great part of the miseries of mankind are brought upon them by false estimates they have made of the value of things.” — Benjamin Franklin. 

If estimates from analysts are correct, there’s a great chance you could record pre-tax returns of about 100% or more by investing in Shell (LSE: RDSB) and Rio Tinto  (LSE: RIO).

5G is here – and shares of this ‘sleeping giant’ could be a great way for you to potentially profit!

According to one leading industry firm, the 5G boom could create a global industry worth US$12.3 TRILLION out of thin air…

And if you click here we’ll show you something that could be key to unlocking 5G’s full potential...

I have very different views on Rio, but Shell is indeed tempting. 

Upside 

The average price target from brokers is 42% higher than Shell’s current stock price of 1,600, according to consensus estimates from Thomson Reuters — and that implies a price target above 2,200p for most analysts.

If the most bullish brokers are right, however, upside could be as much as 170% from Shell’s current level. 

I don’t actually know if you’ll ever record a performance north of 100% investing in Shell in this environment, but I know that under a base-case scenario where oil prices rise between 20% and 30% from their current levels, and based on the possible liquidation value of its assets, its shares should be worth at least 2,000p — and that partly excludes some of the additional benefits that its tie-up with BG may bring.

If I am right, its forward yield will get closer to 6% from its current level of 7.7%. 

It’s virtually meaningless to pay attention either to its 52-week range of 1,502.5p–2,431.5p or to its trading multiples because the “New Shell” that will emerge from the combination with BG — and I am convinced the deal will go through — will be a very different beast. It is useful to consider, though, that key to value creation will be flawless execution from its management team, and this remains the biggest risk for shareholders. 

Management risk also plays a big part when it comes to deciding whether or not to invest in Rio.

Downside 

Most analysts seem to agree that Rio is undervalued by about 30%, and those in the bull camp argue for capital gains in the region of 80% or more. Frankly, I am not convinced that Rio is an appealing equity investment, although the $606m sale of a 40% stake in the Bengalla coal mine in eastern Australia this week was a step in the right direction. 

Its stock should trade at a 20% to 30% discount to its current level based on the fair value of its assets, in my opinion, and such a view is also supported by uncertainty surrounding its payout ratio — a less generous dividend policy is not priced into its stock right now, in my view. I’d be more comfortable with a forward yield closer to 5%, which implies a dividend cut of 20% this year, assuming a constant stock price at 2,200p.

Finally, while I do not think that a rights issue is strictly necessary over the next six months, the debate remains open on whether Rio will be able to withstand the prolonged pressure stemming from a very unpleasant market environment for commodity prices. Its current valuation of 2,230 is only 6% above the low end of its 52-week range (2,090.5p-3,280p), and a technical analyst could argue about a support trendline around this level. 

5 Stocks For Trying To Build Wealth After 50

Markets around the world are reeling from the coronavirus pandemic…

And with so many great companies trading at what look to be ‘discount-bin’ prices, now could be the time for savvy investors to snap up some potential bargains.

But whether you’re a newbie investor or a seasoned pro, deciding which stocks to add to your shopping list can be daunting prospect during such unprecedented times.

Fortunately, The Motley Fool is here to help: our UK Chief Investment Officer and his analyst team have short-listed five companies that they believe STILL boast significant long-term growth prospects despite the global lock-down…

You see, here at The Motley Fool we don’t believe “over-trading” is the right path to financial freedom in retirement; instead, we advocate buying and holding (for AT LEAST three to five years) 15 or more quality companies, with shareholder-focused management teams at the helm.

That’s why we’re sharing the names of all five of these companies in a special investing report that you can download today for FREE. If you’re 50 or over, we believe these stocks could be a great fit for any well-diversified portfolio, and that you can consider building a position in all five right away.

Click here to claim your free copy of this special investing report now!

Alessandro Pasetti 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.

Our 6 'Best Buys Now' Shares

Renowned stock-picker Mark Rogers and his analyst team at The Motley Fool UK have named 6 shares that they believe UK investors should consider buying NOW.

So if you’re looking for more stock ideas to try and best position your portfolio today, then it might be a good day for you. Because we're offering a full 33% off your first year of membership to our flagship share-tipping service, backed by our 'no quibbles' 30-day subscription fee refund guarantee.

Simply click below to discover how you can take advantage of this.