Shell (LSE: SHEL) shares have rallied significantly over the past couple of days. As the oil price has pushed to a multi-year high, investors have bought into the company as it is set to benefit significantly from higher hydrocarbon prices.
Over the past 12 months, the stock has produced a total return of 44%. Over the past three months, it has returned 26%. By comparison, the FTSE 100 has produced a total return of just 16% over the past year.
Earnings growth
Investors have been buying into the stock as City analysts have rushed to upgrade their forecasts for growth over the next two years. A year ago, analysts were expecting the company to report earnings of $1.95 per share for the 2022 financial year. Current forecasts suggest the corporation will earn $3.60 per share. That is an increase of nearly 85%.
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Of course, these figures are only estimates. As such, they are subject to change. If the price of oil continues to rise, the company’s earnings per share could increase even further. On the other hand, if governments decide to levy a windfall tax on oil producers, or if oil prices suddenly collapse, then the firm could undershoot this projection.
Still, I think the outlook for Shell shares has improved dramatically over the past year or so. However, it looks to me as if the market is not yet reflecting this potential.
Indeed, at the time of writing, the stock is trading at a forward price-to-earnings (P/E) multiple of 8.2. That seems to significantly undervalue Shell’s growth potential over the next five and 10 years.
I am not expecting the company to trade at the sort of growth of multiple some technology stocks have been able to achieve, but over the past five years, the stock has traded in at an average P/E of around 12. This implies the business is undervalued by approximately 46%.
Putting a price target on Shell shares
Due to the uncertainties of operating in the oil and gas sectors, this is not a guaranteed price target. There are plenty of risks the company could encounter over the next few years, including sanctions and high operating costs.
Nevertheless, with a year of windfall profits, the corporation should be able to accelerate its transition away from hydrocarbons towards renewable energy.
This could guarantee its future potential in a world that is moving away from hydrocarbon energy sources towards green energy. On top of this potential, the stock also offers a prospective dividend yield of 3.6%.
I would not rule out further cash returns if the group continues to generate substantial profits. Management is already using the company’s windfall to repurchase shares. Further buybacks and even special dividends seem likely if the favourable backdrop continues.
As such, I think Shell shares are a glaring ‘buy’, considering the company’s potential over the next few years. That is why I would snap up the stock for my portfolio today.
