These FTSE 100 value stocks are trading at big discounts

With inflation rising to 2.9% and forecast to move higher, high-yielding shares could become increasingly popular. Investors may find it more challenging over future years to generate a positive real-terms income, which means stocks with relatively high yields could attract valuation premiums.

At the present time, the FTSE 100 has a dividend yield of around 3.8%. While that is only 90 basis points higher than inflation, a number of its constituents offer higher yields. In fact, its two highest-yielding shares are BP (LSE: BP) and Shell (LSE: RDSB). They offer 6.5% and 6.7% respectively, and now could be the perfect time to buy them

Improving outlooks

While the oil price has been a source of major disappointment in recent years, its prospects appear to be improving. The decision by OPEC to cut production generated an opportunity for demand to start to catch up to supply. Since the original supply cut has been extended for a further nine months, there could be an opportunity for the glut in excess supply to gradually be reduced over the medium term.

This could push the price of oil higher in the coming months, while the prospects for ‘black gold’ in the long run may also be relatively positive. Demand from emerging economies such as China and India is forecast to rise, which could act as a positive catalyst on the oil price. Furthermore, with the US leaving the Paris climate agreement recently, the transition towards cleaner forms of energy may be slower than it has been in the past.

Fundamental strength

As well as a potentially upbeat outlook for the wider industry. Both Shell and BP appear to have sound strategies to deliver improving profit growth in future. For example, Shell’s cash flow is due to increase as it begins to benefit from the BG acquisition. As well as this, lower costs have made the business more efficient, which may make dividends more affordable over the medium term.

It’s a similar story for BP. The company’s cash flow has the potential to improve in future owing to the end of its financial obligations regarding the oil spill from 2010. This could allow the company more scope to invest in its asset base, as well as reward shareholders. Since BP has made its dividend a priority in recent years, it seems likely that it will seek to deliver dividend growth which is at least ahead of inflation over the medium term.

Investment appeal

As well as their high yields and scope for rising dividends, both stocks appear to offer excellent value for money. For example, Shell has a price-to-earnings growth (PEG) ratio of just 0.6, while BP’s PEG ratio is slightly lower at 0.5. Given their dominant positions within the oil & gas industry, as well as their diversity and income potential, their valuations appear to be low. As such, buying them now could prove to be a shrewd move.

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Peter Stephens owns shares of BP and Royal Dutch Shell B. The Motley Fool UK has recommended BP and Royal Dutch Shell B. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.