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Home Investing ideas Shares
Published 10 August 2022
Fidelity International
Important information: The value of investments and the income from them can go down as well as up, so you may get back less than you invest.
NOT all companies have suffered this year amid the otherwise widespread falls in stock markets.
Sectors that stand to gain from the inflationary spiral in commodity prices have done very well indeed. In the UK that includes the oil majors BP and Shell, the shares of which have posted 21% and 29% gains respectively in the year so far. That’s compared to a 3.4% fall for the FTSE All-Share over the same period.
It would have paid off handsomely to have been invested in the two companies at the start of the current crisis in January. But does that mean it would no longer pay off to invest in them now?
Investors are trained to think that the market immediately prices in the news that affects companies – both positive and negative. Any spike in the oil price, like we’ve seen over the past year, would be reflected directly in the share prices of oil companies – right? In general, that’s true, but it doesn’t mean the share prices of oil companies always reflect oil prices perfectly.
It’s a point that was made by Jonathan Waghorn, fund manager of the Guinness Global Energy and Guinness Sustainable Energy funds, in a conversation we recorded recently for our weekly Personal Investor podcast.
Jonathan explained that he uses valuation models to estimate the fair value for an oil company’s shares based on the current level of the oil price.
He added: “I can run my valuation models in reverse. If I put in today’s share price, what oil price explains that share price? Across my portfolios it’s about $59 a barrel. At that level we think shares are at fair value. If we have a $70 long-term oil price, there’s 35-40% upside in the share price. At $80 a barrel it’s more like 70-80% upside.”
It won’t have escaped your attention that oil prices are some way above those levels, with Brent Crude currently at $96 a barrel.
Does that mean oil company shares are a sure thing at these levels? Certainly not. As Jonathan explained, oil is a cyclical business and one which will be hurt in an economic slowdown where demand falls – which is where we may well be heading. Returns can be volatile, as can the oil price itself and these companies will increasingly find themselves in the crosshairs of governments who need to ease the burden of high energy prices on households.
Nevertheless – some will see a strong value case for investing in oil companies now, even after the strong gains they’ve made this year. BP and Shell currently yield between 3-4% in dividends with free cash flow yield – a technical measure that professional investors use to assess the value of companies – at historically high levels, meaning that dividends should be well covered by the cash being generated.
They may not be the most popular companies right now, but that doesn’t mean the conditions for oil companies aren’t very favourable – and may stay that way for some time yet.
Past performance is not a reliable indicator of future returns
Source: FE from 10.8.17 to 10.8.22 Basis: Total returns in GBP. Excludes initial charge.
Important information: Investors should note that the views expressed may no longer be current and may have already been acted upon. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to one of Fidelity’s advisers or an authorised financial adviser of your choice.
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Please remember that past performance is not necessarily a guide to future performance, the performance of investments is not guaranteed, and the value of your investments can go down as well as up, so you may get back less than you invest. When investments have particular tax features, these will depend on your personal circumstances and tax rules may change in the future. This website does not contain any personal recommendations for a particular course of action, service or product. You should regularly review your investment objectives and choices and, if you are unsure whether an investment is suitable for you, you should contact an authorised financial adviser. Before opening an account, please read the ‘Doing Business with Fidelity’ document which incorporates our client terms. Prior to investing into a fund, please read the relevant key information document which contains important information about the fund.
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