One Wrong Reason to Buy Royal Dutch Shell's Shares

By Alex DUMORTIER, CFAFool.com

U.S. stocks are showing small gains on Wednesday afternoon, with the Dow Jones Industrial Average and the benchmark S&P 500 down0.33% and 0.25%,respectively,at 1:30 p.m. EDT.

Source: Ben Lunsford.

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I'm convinced that the slump in energy companies' shares resulting from the sharp drop in the price of oil has created opportunity for patient, value-driven stockpickers. Among the oil and gas supermajors, looks like it could be just such an opportunity. Nevertheless, there is one reason that isn't adequate justification for buying shares: the current dividend yield, which stands at an alluring 4.7%.

My Fool U.K. colleague Rupert Hargreaves recently pointed to Shell's dividend history in support of the future dividend's sustainability, writing that "Shell has paid and increased its dividend every year since the end of the Second World War, and that's an illustrious record management won't want to break anytime soon."

However,"wants" must sometimes cede to "needs" when a company (or, indeed, an entire industry) is under duress. For example, on Feb. 27, 2009, industrial conglomerate cuts its dividend for the first time since 1938 (by more than a third, from $0.31 to $0.10 per share).

The next day, the stock fell 10.6% taking GE's dividend yield from 14.6% to 5.3%. (Nevertheless, this turned out to be an outstanding opportunity to buy GE: The current dividend represents a 12.1% yield on that trough price.)

Shell considers its dividend is "core," recognizing that the shares are a mainstay of income-oriented U.K.investment funds. Furthermore, Shell acquired a reputation for conducting itself with a pronounced conservatism. However, I wonder if this reputation, which reflects a distinguished corporate history, is still representative of its present position.

In a blog post(click-throughfree with registration)on the Financial Times website, which ought to be required reading for Shell investors, Nick Butler argues the two are inconsistent:

Those three bets are: First, the acquisition of BG Group. Second, Arctic drilling of the north-west coast of Alaska. Third, a proposed strategic alliance with Russia's Gazprom. All three of whichButler finds out of character for Shell:

I believe Shell's dividend is safe for at least the next couple of quarters. However, were the price of oil to remain depressed lower and longer than most people now expect (the next couple of years, say), the dividend would be in real jeopardy.

At least some investors (or speculators) share this view: At today's close, Shell's December 2017 dividend futures is priced at nearly a 30% discount to the dividend futures expiring this coming December.

The article One Wrong Reason to Buy Royal Dutch Shell's Shares originally appeared on Fool.com.

Alex Dumortier, CFA, has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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