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Should I plunge into Shell and collect its 5%+ yield, or is caution needed?

From an investment point of view, the most striking thing about FTSE 100 oil giant Royal Dutch Shell (LSE: RDSB) is its gargantuan dividend yield running at around 5.75%. But the payout has been flat for at least the past five years, and City analysts following the firm don’t expect any improvement in the current trading year or in 2020.

Shell fails my first basic test

Shell fails my first basic test for a dividend-led investment, which is that the dividend should rise a little each year. Digging into the firm’s financial record reveals why the company is having difficulty raising its dividend, as you can see from the following table:

Year to December

2013

2014

2015

2016

2017

2018

Normalised earnings per share ($)

2.57

2.09

0.70

0.58

1.95

2.79

Operating cash flow per share ($)

6.43

7.14

4.66

2.61

4.30

6.36

Dividend per share ($)

1.80

1.88

1.88

1.88

1.88

1.88

Earnings dipped in 2015 and 2016 before returning to roughly where they were five years ago, and it’s been a similar story with the company’s operating cash flow. No wonder Shell couldn’t raise its dividend. I think the table reveals how vulnerable the firm is to the fluctuating price of oil.

I wrote in an article just over a year ago that the share-price chart reveals how volatile the stock can be because of its cyclicality.” Indeed, you can match the weakness in Shell’s financial figures and the big dip in its share price of recent years with the weakness on the oil-price chart. What I said a year ago still holds true today: “Commodity prices have been firmer lately, but that situation can reverse, and if the share price declines, the capital you lose could wipe out years of income gains from the dividend.”

Every little helps

Yet there are some things Shell can do with the aim of keeping total returns flowing for shareholders. Today, for example, the firm announced the start of the next $2.75bn tranche of its share buyback programme announced in July 2018.  The company aims to have bought back “at least”$25bn of its shares by the end of 2020, but there’s a caveat. The ongoing buyback programme is “subject to further progress with debt reduction and oil price conditions.” As already mentioned, the price of oil is unpredictable and out of the directors’ hands.

Nevertheless, when a company buys back some of its own shares, the share count is reduced, which means the dividend cash is spread less thinly, thus driving the yield up for shareholders. So, I think the buyback programme makes good use of Shell’s surplus cash inflow.

Meanwhile, chief executive Ben van Beurden said in today’s first-quarter results report that “Shell has made a strong start to 2019, with the first quarter financial performance demonstrating the strength of our strategy and the quality of our portfolio of assets.”

But no-one is predicting any meaningful growth in earnings or the dividend from the company over the next couple of years, so I’d rather mitigate the single company and cyclical risks of investing in Shell by investing in an FTSE 100 tracker fund instead.

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Kevin Godbold has no position in any share mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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.