Royal Dutch Shell: A Case Study in Investing During Bust Cycles

The oil market began to tank during the second half of 2014, around the same time that I actually had money to begin investing somewhat seriously. Obviously, I had missed the rock bottom prices of the 2008-09 crash, so finding dirt cheap (based on valuation) stocks to buy wasn’t necessarily an easy proposition. Sure, prices overall have gone up even higher since then, but I’m talking about investing in a company when nobody seems to want it  and you can’t buy positive news related to its outlook. As such, I became quite interesting in getting into the energy sector as it was falling, particularly the integrated oil majors. One of these companies was Royal Dutch Shell, and watching it fall from its trading high in the upper $80s during 2014, to bottoming out at around $37 in January 2016 was fascinating. In fact, it was like a complete course in investing, keeping calm, and how high dividend yields act as an accelerant when things turn around. This case study, is my personal experience, lessons learned, and the investment returns under different scenarios.

 

Lesson #1: On Catching a Falling Knife

There’s a phrase within the investment community, “catching a falling knife”. Essentially, it means investing in a stock that has experienced sharp losses, and expecting it to turn around. Sure, the stock can look cheap if it’s trading 30% off of its high, but what’s to stop it from sinking even lower?

You think you’re getting a discount, when in actuality, it can continue to go south all the way to zero. Maybe you get lucky or maybe you get cut up bad by that falling blade.

The situation with Royal Dutch Shell was looking pretty bad by the time that I made my first foray into owning the stock. It had fallen from a high of $88 per share (from the charts I’ve seen) in the summer of 2014, all the way down to $62.74 when I bought in on March 10, 2015. A pretty hefty 28.7% loss in under a year. Yikes.

The cause of this loss in share price? The oil market had busted and the price per barrel was taking a nose dive. It’s not great for the revenue of a company that trades in commodities, when the price of their main commodity is getting destroyed on the open market.

Even with that being the case, I made my first small investment anyway. Why? Didn’t I understand about ‘catching a falling knife’?

Why yes, I did. I also thought that there was a potential for the price to drop even further from that point (and boy did it). Then, what was the rationale? There are many things that I considered but here’s why investing in Royal Dutch Shell seemed like a fair move at the time.


Investment Horizon

One of the main reasons that I felt comfortable opening a position in the company, is that I believed in it in the long-term. My timeline for investment returns was going to be measured in decades, not a few months or even years.

The components of the company had been around for over 100 years and they hadn’t cut the dividend since WWII. So, this wasn’t some fly by night operation. They had been through plenty of oil busts before and I felt that they had the wherewithal to get through another one…even if it got really ugly.

If the price dropped further, I had no plans on selling out my position, due to paper losses. It’s not a loss until you sell, after all. As I thought 10-20 years in the future, did I think that Shell would still be a premier energy company? Yep. Did I think the share price would be higher? Almost certainly.

The risk/reward profile seemed to be a decent play and I was being given a starting 5.99% dividend yield, to sit and wait for the recovery.

Easing into the Investment versus Lump Sum

Because I had such a long-term holding period in mind for this company, I didn’t feel the need to throw in one huge investment at the initial price I bought in at.

Plus, since I felt that the carnage of the oil market might continue for a while longer, there might be a good chance to get better prices by spacing out my investments. Here’s how those spaced out investments turned out:

Initial investment on 3/10/15 (price per share): $62.74

2nd investment on 6/16/15: $58.87

3rd investment on 1/7/16- $42.91

4th investment on 5/16/17- $58.31

5th investment on 6/27/17- $55.07

Now, I completely didn’t stick to a regular investment schedule by having cash deposited in my brokerage accounts monthly or whatever. That was partially a lack of paying attention on my part and partially deploying capital into other investments (and oil majors) during that same time frame.

Also, these investments weren’t of equal amounts of cash. Still, I lowered my cost basis significantly over the course of time. This becomes especially true when dividends are factored in.

The Dividend

As I’ve already mentioned, with my initial investment offered a 5.99% starting dividend yield. There was already chatter going around investment websites such as Seeking Alpha, about the possibility of a dividend cut coming soon for Shell.

A dividend cut at that time, would having been pretty devastating to the price of the stock, and undermined faith in the company. However, when I looked closely, I thought that company could probably hold out for at least 18 months before a cut would come. Possibly a bit longer, depending on how the market recovered or didn’t.

Trust me, when January 2016 came around, and oil bottomed out…things weren’t looking great. It had been almost a year since I first invested and things had only gotten worse for the company’s prospects, and for the odds of a dividend cut.

Once again, rationality brought me through any cloud of doubt which arose. Would it have been such a bad thing for me to have the dividend yield slashed in half? 3% wouldn’t be terrible and I still felt that Shell’s assets were too valuable in the long-term to bail out.

Plus, who at that company wanted to be the first person to cut the dividend in 70 or so years? I had a hunch the board would do whatever to keep the dividend unchanged throughout the bust cycle. This turned out to be true.

The Economy

One of the other main reasons, I felt comfortable catching a falling knife, in this scenario? The global economy was still growing.

Now, it certainly wasn’t tearing it up, but I didn’t see the likelihood of oil completely collapsing into oblivion if the economy was headed up. More growth would equal more energy used. Heck, lower oil prices would probably help the rest of the economy outside of the energy industry.

What I figured would happen is that the oil market would bottom out relatively quickly, once the weakest companies folded, and supplies tightened. We were awash with oil, there was some geo-political shenanigans going on to keep the price low, etc. But at some point, the turn around would happen, and the price would move higher.

I was banking on the oil market hitting rock bottom and then being dragged up by economic growth. It was definitely a risk to bet on that happening, but I thought it would, somewhat quickly. Just not as quick of a turn around, as it ended up being.

Either way, my approach was to prepare for an oil bear market that would last years, and deploy cash to buy up shares in the integrated oil majors that I thought would end up surviving a long-term purge.

Lesson #2: Become Detached from Market Fluctuations

It’s a hell of a feeling to log into your brokerage account and see that the shares you have purchased are down a whopping 41%. That’s enough to rouse the natural urge to want to cut your losses and try to salvage anything that you can. This was the situation that I found myself in January 2016, when the price of RDS-B stock dropped all the way down to $37 per share.

This is where trusting the process comes into play. I knew going into this that the bear market in oil might get worse and the prices could seemingly go into free fall. Was there anything inherently wrong with the company? Not really. It would certainly need to continue to restructure in the new environment, but I still thought it would also be one of the big time survivors of these lean times.

On the bright side, the second purchase of Royal Dutch Shell shares I made at $58.87 were only down about 37%. Plus, the reinvested dividends took some of the edge off, even though those extra shares had fallen in price right along with the predecessors.

Having a long-term investment plan, not only gives you a vision of the future to work towards, it allows you to accept the short-term ups and downs because you had no plans to sell anyway.

You’re an owner of the company. Not a trader. You understand that the business cycle exists and that the booms and busts are especially true in the energy sector. Not only that, you expect the price to drop dramatically at times during your ownership.

Hell, companies like Pepsi, Coca-Cola, and Johnson & Johnson; have all experienced dramatic drops in their share prices. If you had purchased shares in one of these companies back before the 1987 downturn in the market. You got whacked. If you held on, you got whacked again during the dot-com bubble. Then again in 2008-09.

However, during that 30+ year stretch, your wealth grew dramatically. There’s a good chance you’d be cashing more in dividends each year now, than you would have initially invested in any of those companies…not to mention the huge rise in stock price. Though, you still had to sit through those periods of 40-50% on paper losses from previous highs, and not panic sell off every share you owned. It’s not a straight ride upward in price, there are plenty of peaks and valleys along the way.

I knew that I would probably be okay in the long-term with the 41% on paper losses, that were shown on my computer screen for my initial Shell investment. I even saw it as another buying opportunity and grabbed more shares at $42.91, before watching those fall to $37. The consolation being, that I locked in an 8.76% dividend yield on those new shares.

The long-term vision for your investments is probably the best medicine to cure the itch to sell off your shares during a downturn. A sense of historical perspective is also very useful. This is where having studied a bit on market panics and sharp drops in prices, has come in handy for me.

I can look back to as recently as the 2008-09 market crash and hear the constant media refrain as the, “worst since the Great Depression”, ad nauseam. Were companies like Visa, Mastercard, and Nike going to go out of business? Short of nuclear war or some other massive destructive even, nope. Yet, you can go back and look at the price charts for these giant corporations, and see them trading at 8x more today or thereabouts from the 2009 market lows.

Finally, beyond having a plan and perspective on historical fluctuations; I think that temperament is also quite important. People that aren’t super smart but have a patient and methodical and even disposition, will probably be better investors in individual stocks than those who are very intelligent but impulsive as hell.

Even tempered people can set their contributions and forget it. “Oh, my stock dropped dramatically? Should I buy more?” is the thought process that many of the best investors will have. They don’t panic sell and usually only sell at all for very specific reasons. Meanwhile, the impulsive and fearful person, will jump in and out of positions and absolutely destroy their overall returns.

Now, I can personally be somewhat impulsive in other areas of my life, but luckily with my investments I have a much more stay the course attitude. I think that it’s important as an investor to recognize your own behavioral weaknesses and figure out how to limit them, so as to not screw up your money making abilities.

Do you take too much risk? Are you too risk averse? Think you know more than you probably do? Can’t stand to see those on paper losses? Taking the time to mitigate these sorts of behavioral quirks, can save you untold amounts of money in the long run by steering you away from mistakes. Also, it can make your decision making tighter, and perhaps juice your returns.

Lesson #3: The Investment Rocket Fuel of Dividends

Royal Dutch Shell Returns since the Oil Bust in Different Scenarios

Alright, I am going to take a closer look at how an investment in Royal Dutch Shell has faired since the oil bust in three different scenarios: my own personal investment returns, buying at the bottom and not reinvesting dividends, and buying at the bottom and reinvesting dividends for the first two years.

I want to show my own results and how my almost completely random timing of purchases actually has faired during a market bust and recovery. This, along with the other two scenarios, should demonstrate the absolutely insane effect that dividends can have on returns when markets recover. In particular, high yield dividends like we got to see with RDS-B.

Before I dive into all of that, I need to briefly explain the quirks of owning stock in this particular company. Royal Dutch Shell has two classes of shares A and B. Why? The company used to be two separate firms, one headquartered in the UK and the other in the Netherlands.

RDS-A shares are the Dutch shares and USA investors pay a 15% withholding tax on the dividends received. RDS-B shares are the UK based shares for American investors and due to a tax treaty, there is no withholding tax.

Now, to complicate things a bit further. During most of the investment time period covered here, if one owned RDS-B shares and reinvested the dividends, you were given ‘A’ shares. This was due to the temporary Scrip Dividend program. The details aren’t important for our purposes, but for a span of time, my reinvested dividends bought me the Dutch RDS-A shares and subsequent dividends generated by those A shares got charged the 15% withholding tax…yeah, it’s kind of a mess.

Nowadays, the Scrip program has ended and B share dividends buy B share stock. While, A shares buy you new A shares. Hopefully, this all makes some sense.

 

My Investment Returns in Royal Dutch Shell

Just as a reminder, here are my purchase prices for my investment into RDS-B:

Initial investment on 3/10/15 (price per share): $62.74

2nd investment on 6/16/15: $58.87

3rd investment on 1/7/16- $42.91

4th investment on 5/16/17- $58.31

5th investment on 6/27/17- $55.07

Five separate purchases, on the way down starting in 2015 and during the turn around period in 2017. I also only reinvested all of my dividends from 2015-2017 and have done partial reinvestment for 2018. Meaning, the shares in my taxable brokerage account, I take as cash. In my Roth IRA, I reinvest the dividends into more shares.

Here are my results as of market close on 10/5/18:

Appreciation in share value: +44.8%

Percentage of initial investment returned as dividends: 15.3%

Current dividend yield on initial amount invested: 7.35%

This is the power of share appreciation with a healthy dose of high dividend yield. Remember, my initial purchases were down 37-41% at one time. Now, the entire position is up by 44.8%. Not only that, I’m collecting over 7% of that total investment each year in straight cash or new shares…which throws off more future cash dividends.

Also, my shares that I purchased near the bottom at $40.92 are up 72% from that price. The price of RDS-B has declined some from its 52 week high, as these cheap shares were up 88% a few months ago.

It’s really a double whammy of appreciation in share price and a high starting dividend yield. Not only have I gotten great gains after experiencing a sharp drop, I also have already collected over 15% of my total investment in dividends alone. Add to the fact, that my current yield is 7.35% each year, and Shell has frozen its dividend in place this entire time.

Can you start to see the acceleration of returns when they raise the dividend in the future? I think there is a good shot at them raising the dividend in 2019, which will just pile on the cash even further. All of this, in under three years, and having to spend some of that time in a market that was utterly crashing.

Now, let’s see what happened for any investor who actually caught the bottom.

 

Royal Dutch Share Investment Returns with No Dividend Reinvestment

While my returns are nice, they actually pale in comparison to what they potentially could’ve been. This is due to my inconsistent investments and not pulling the trigger when I knew that I should.

I wrote earlier about temperament when it comes to investing. Well, sometimes, I’m way too conservative with my money and don’t take risks that I have the means to take. I bought those cheap shares of RDS-B at 42.91, but had another major investment in mind, while the stock kept falling below $40. I was going to more than double my position and would’ve gotten more shares yielding over 9%.

What actually happened? I chickened out, basically. Instead of transferring the money to my brokerage account, I took a wait and see approach. Not only did I not double my position, I didn’t even put another fraction of that total, into buying up these cheap shares. This was the opportunity that I had been waiting for in the market for over a year and then I didn’t even make my move.

Sure, I’ve still managed to do well, and I’ll be collecting cash from the actions that I did take for a long time to come…but, damn, I screwed this one as you’ll see in the scenarios presented below. First, the investment without dividend reinvestment.

Investing $10000 into RDS-B near the lows

Let’s say that I had bought $10000 of Royal Dutch Shell stock in January 2016 when it was trading below $40. Purchasing 267 shares of RDS-B at $37.50 per share for a total of $10012.50 (I needed to get to a whole share count and there would probably also be a commission to pay as well).

Those 267 shares each paid a quarterly dividend of $0.94, which is $3.76 each year. This is a total yearly dividend total of $1003.92 representing a 10.03% yield.

Fuckin’ hell.

Okay, let’s check out the returns:

Initial investment: $10012.5

Cash dividends received: $2760.78

Current value of 267 RDS-B shares: $18786.12

Combined Dividend and Current Share value: $21546.3 (+115.2%)

 

Yep, in less than three years, I would’ve more than doubled my money just in stock price appreciation. On top of that, collected 27.6% of the initial investment in cash, with another dividend payment on the way in December 2018.

Just to put that annual dividend of $1003.92 into perspective: one would need to own somewhere in the neighborhood of $66-67K worth of a fund such as the Vanguard Total Stock Market Index Fund, in order to generate the same cash (based on 2017 payouts). This all would’ve been achieved with $10000 of RDS-B.

You only need a few big wins in your lifetime, to set up a nice future.

 

Royal Dutch Shell Returns with Dividends Reinvested

Now, let’s run through the same scenario of purchasing 267 shares of RDS-B at $37.50, but reinvesting the dividends back into the company.

Remember, the B shares at this time were being reinvested into buying RDS-A shares, which have the 15% Dutch withholding tax. So, I’ve taken that amount out for the reinvestments.

Also, I’m going to assume that the reinvestment only took place during 2016 and 2017. For the current year, I’ll take all the dividends as cash. For each dividend reinvestment, I used the actual price that I received the shares on that day in my own personal account.

So, what does the same investment look like with reinvestment for the first two years?

Initial investment amount: $10012.5

2018 Total RDS-B Shares owned: 267

2018 Total RDS-A Shares owned through reinvestment: 39.994

Current Value of B Shares: $18786.12

Current Value of A Shares: $2733.59

2018 Cash Dividends Received Thus Far: $848.81

Total Value of All Share and Cash: $22368.52 (+123.4%)

Current dividend yield on initial purchase: 11.32%

 

As you can see, dividend reinvestment boosted the returns by only 8.2% during this time period. Why? Well, it has only been a couple of years and the return acceleration of those reinvested dividends haven’t fully kicked in yet. More importantly, that 15% tax on the RDS-A shares took quite a bite of the gains.

However, in this scenario, one has accumulated about 40 more shares in the form of RDS-A and now has a dividend yield on cost of 11.32%, which is utterly insane!

Imagine a scenario in which, Shell boosts the dividend by 10 percent after this long freeze. You’d be looking at collecting 12.45% of your initial investment for that next year and if the increases kept coming, look out…

I hope it’s been illustrative about how the price you pay for a stock effects returns. Especially, when you’re talking about a blue chip stock that has been battered, and offers a high initial dividend yield that is sustainable.

Not only did the value of the shares more than double in this short couple years, but one would be looking at receiving their entire initial purchase price back just in dividends, in less than a decade. That’s something that usually takes around 3 decades to accomplish.

Wrapping it All Up

There are times when the stock market is going to drop and drop hard. It might be the entire economy or other times it might just be isolated to one sector. In 2016, the energy sector was in this very scenario, and people were fleeing to the exits. This panic and drop in energy prices, allowed for those with cash to step in and buy assets on the cheap.

These cheap shares of stock, have in turn, produced insanely accelerated results in a short period of time. Beyond that, investments in certain integrated oil majors (such as Shell and BP), offered once in a generation starting dividend yields which have and will continue to act like adding fuel to an already raging fire.

Was this necessarily the outcome of an investment at this time? No. It could’ve been a sustained energy bear market, in which case, investments in these firms during the 2016 period would have resulted in overpaying for assets. There’s no guarantees and risks are always abound.

Ultimately, there are times when these sorts of opportunities present themselves. Knowing how the price you pay and the starting dividend yield can juice your gains, will give you a better ability to recognize these opportunities. Even if you don’t play it perfect, a few sound decisions during these star-aligning times, can have a big impact on your future results. Heck timing things right, could knock years off the race to retirement, and produce wealth that can change life entirely.

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