As an investor, it is all too easy to become disillusioned. That’s because, inevitably, investments rarely work out as planned since there is always an internal factor within a company that has been overlooked, or else an external factor pops up to derail the profit that was expected. As such, buying and selling shares is not for those people who are unable to deal with disappointment.
One stock which has been hugely disappointing in recent years is oil major BP (LSE: BP). It has endured a painful period, kicking off with the tragic oil spill in the Gulf of Mexico in 2010 which has cost the company £billions in compensation payments and greatly hurt investor sentiment in the stock.
In fact, prior to the oil spill in April 2010 BP’s share price was 650p and it now trades at just 378p. Of course, not all of this fall is due to the cost of the oil spill. The price of oil has also collapsed during this period, with it falling from well over $100 per barrel in 2014 to less than $50 per barrel. Clearly, a global supply/demand imbalance is to blame, but looking ahead it is estimated that global energy demand will rise by 30% in the next twenty years.
In addition, with countries such as China and India likely to remain highly dependent upon fossil fuels even as renewable energy sources become more cost effective, the long term outlook for oil may not be anywhere near as negative as many investors currently believe. That’s especially the case since most oil companies are cutting back on exploration spend, which means that the supply of oil is likely to come under pressure in the coming years. Therefore, a rising oil price could boost BP’s profitability and improve investor sentiment over the medium term.
Meanwhile, BP’s valuation remains hugely appealing even when the fall in net profit is taken into account. Certainly, BP’s bottom line fell by 83% next year but it is forecast to rise by 63% in the current year and by a further 9% next year. This puts it on a price to earnings growth (PEG) ratio of just 0.8, which indicates that its shares offer significant upside potential. Furthermore, and while there is potential for asset writedowns as the economic value of oil projects slide, BP’s price to book value (P/B) ratio of 1 indicates that it offers a relatively wide margin of safety.
Clearly, there is the potential for additional external factors to have a negative impact on BP’s financial performance. However, the prospect of a higher oil price in the long run plus the end of compensation payouts are two external factors which are likely to have a positive impact on the company’s valuation. And, as mentioned above, there is plenty of scope for an upward rerating in 2016 and beyond.