Shell Stock Purchase (RDSB) – The Best of Big Oil

During the recent oil price volatility and subsequent crash in the stock prices of oil companies, I managed to buy some shares of one of the best integrated oil companies in the world, Shell.

I purchased 214 shares at an average price of £15.60 thus bagging myself an astonishing dividend yield of 8%. This means that shell will pay me dividends of £66 every quarter or £264 annually.

I am gobsmacked by the yield many of the oil majors are currently offering. This 8% dividend yield offered by Shell is unreal. It is rare to see a yield that high which is still being covered by a company’s current profits (just about!). With oil stocks at the moment, investors are being paid to absorb a heck load of volatility. Though I do not expect Shell to grow its dividends in the near future, simply re-investing current dividends will provide me with double digit long term returns, providing the stock remains undervalued. This is a phenomenon potential awaiting an already behemoth company that generates nearly half a trillion dollars in annual revenue.

If the dividends do not grow at all from this point at mentioned, investors would still be getting a phenomenal return. Imagine this, if Shell maintains its current dividend payments, you will receive £1.25 a share annually. This means that In a decade from now, I could end up recouping 80% of my initial cost; or much more if you re-invest dividends. 

And the great thing about the above calculation is that is at the low end of my estimate as I have not included any dividend growth. Once oil prices recover, which I am certain will be the case, I am certain Shell will increase its dividend payments over time thus ensuring I recoup my ‘initial cost’ much quicker.

It is surprising how many people:

  1. underestimate the value of high-yielding stocks that are able to grow moderately over the long haul, and
  2. run away immediately when the price of the stock falls.

People look back at firms like Wells Fargo, Barclays, Starbucks, and General Electric during the financial crisis and wish that they could have positioned themselves well for rapid dividend growth and strong returns in the years ahead. Well, in order to receive those superior returns, you had to set aside recency bias, absorb market volatility, and think in terms of an entire business cycle by recognising how lucrative margin of safety mixed with dividend reinvestment can truly be. Large commodity companies don’t disappear–the earnings slump is the reason for the undervaluation–and that is why these are good value stocks.

Royal Dutch Shell gives you an opportunity to build that kind of income. Heck, someone that buys 100 shares of Shell today and clicks the reinvest button will be owning around 108 shares of Shell in a years time. Even immediately, the ball gets rolling.

This is a great time to buy Shell for a long term investor

Shell is a truly wonderful business. Looking at its history, Shell returned over 14% annually from 1907 through 2007 for people that reinvested. The earnings growth rate of the firm was only 7%. The rest came from the dividend, and the added effect of reinvesting when the price of the stock was undervalued. It’s one of the most neglected areas of the stock–an investment of £1,000 in 1907 would have grown to over £1.1 billion today excluding taxes.

Shell stock has once again found itself in a position that may very well deliver12% to 13% annual returns for investors. The £15.60 per share price of the stock makes it one of the most irrationally valued large-caps in the world if you are looking out 20+ years.

Looking at the price of Royal Dutch Shell today, it does give you the Margin of Safety which Ben Graham talked about; getting a good entry price really does give you the portfolio protection you need. Imagine if, in 2008 and 2009, you saw Royal Dutch Shell price’s decline into the $12.80 as the price of oil got cheap and the backdrop of an economic crisis made the stock cheaper than long-term projection of oil fundamentals warrant.

Today, there may not be the backdrop of economic crisis that we had six years ago, but the fundamentals (in the short term) for oil have been impaired much more than was the case in 2008-2009.

But look at what happened to investor that has held onto the stock for six years: You received £1.13 in each year from 2009 through 2011, got £1.16 in 2012, received £1.21 in 2013, collected £1.25 in 2014 and £1.25 in 2015. You got to collect £8.26 in cash dividends from Royal Dutch Shell over the course of seven years.  You got to collect over half of your initial investment back in the form of cold hard cash.

As I have written before news is noise and you should do your best to ignore it. The current headlines talking about the horrors in the oil markets should not cause you to panic as a long term investor, especially if you purchased the stock at a decent price. If you count the effect of dividends, someone that purchased the stock at £12.80 during the financial crises, you would be up £2.8 in share price and £8.26 in dividends making a total of £11.06. You would be up by over 80! You get this great return even though the price of oil has fallen over 60% in the past year and stock prices of oil producers have followed followed suit, and yet you are still almost doubled your money.

For a long term investor, Royal Dutch Shell will prove to be a great investment. Even with the low oil price, Shell remains wildly profitable. This is one of the great attributes of an integrated oil company. It is the high refining profits, and chemical profits, when oil gets cheap that allows companies like Exxon, Chevron and Shell  to keep paying dividends and also go on the offensive to purchase upstream companies outright that are unable to take on additional debt to survive. It’s the most predictable form of industry consolidation; it happened in 1986, 1999, 2009, and it will happen again now.

Will Shell cut its dividends?

Shell hasn’t cut its dividend since the end of World War 2 – That is 70 consecutive years where Shell has either maintained or increased its dividend payment. A phenomenal record!

Kinder Morgan was one of the first big players in the oil industry to cut its dividend earlier this month and many believe other oil companies will follow suit. The current dividend yield offered by Shell stock is disparagingly high and many people fear that a dividend cut may be in the pipelines especially with the proposed acquisition of BG.  Shell has also called it quits on projects in the Northwest–Alaska and parts of Canada–as the sustained environment of $40 oil has made it impossible to turn a profit on drilling. This resulted in a huge write-off that forced Royal Dutch Shell to report -$2.32 in third quarter earnings – the first quarterly loss for the company in over a decade!

Shell currently has a high dividend payout ratio which just about touches 100%. This means that shell pays out all its profits in the form of dividends.  If the oil price stays in the doldrums of under $40 a barrel, these dividends and the dividend cannot be sustained.

That said, I don’t think Shell will be cutting its dividend anytime soon. The company has taken steps to shore up its balance sheet by bringing back the Scrip Programme to pay shareholders their dividends in the form of stock instead of cash outlays. It’s a classic example of a low cost of capital move–the shareholders get diluted just a bit from 3.25 billion to 3.255 billion as a result of this decision, but the oil giant keeps to keep cash on its hand to ride out the storm.

Early in 2014, the company tapped the credit markets in order to prepare for an extended period of low oil prices. Whilst some of this will go towards the BG acquisition, I imagine that money will be used to pay the dividend and acquire upstream producers that are flirting with bankruptcy. Whilst taking on debt is something I abhor in a company, the debt taken on by Shell is manageable even at these low oil prices due to the rock bottom interest rates and when the oil price recovers, the debt taken on for acquisitions will magnify future returns.

The Queen owns Shell in her portfolio.

When doing my research on Shell, I came across something really interesting. Queen Elizabeth and Queen Beatrix own enormous blocks of millions of shares of Royal Dutch Shell stock. Queen Elizabeth receives more dividend income per year than the sum of all her personal and philanthropic annual initiatives, and Queen Beatrix from the Dutch House of Orange has been one of the few monarchs to enlarge her economic might in the past quarter-century because of her unusually large position in Shell stock.

These royals know what many seem to miss – Shell pumps out a lot of cash which it distributes to its shareholders in the form of ever increasing dividend payments. There aren’t many companies that can see their profits cut in half, the share price follow suit, and still ensure that investors double their money over the previous seven years. This is exactly what happens when you mix a value investing price with high dividends from a tried and tested company. The long-term history of Shell is off the charts–with nearly 14% annual returns over the course of the 20th century. 

Oil majors are currently trading at prices that gives small investors the opportunity to buy  his or her own oil well.  Even though the ride will be rocky, it really is one of those things that starts putting a lot of cash in your pocket on a regular basis compared to the relatively small amount of initial capital that you have to contribute initially. For a long term investor, the current oil price decline can prove to be the opportunity that will make you very rich over the course of your life.