The tax-free nature of an ISA means that it’s perfect for stocks that pay a hefty dividend.
BP’s (LSE: BP) dividend yield is one of the best around. The company’s shares currently yield 5.9%, but is BP a suitable pick for your ISA?
Risks ahead
Unlike many of the FTSE 100‘s blue-chip companies, BP is riskier than average. Indeed, the company’s exposure to Russia, as well as its Gulf of Mexico liabilities, means that BP comes with a high-risk warning.
If the situation between Russia and the West deteriorates further, it’s possible that BP’s near 20% share of Russian oil giant Rosneft could be seized by the state, which would cost BP billions.
BP is also facing the prospect of additional fines stemming from its role in the Gulf of Mexico disaster.
Still, it’s not all doom and gloom. BP is one of the world’s largest oil companies and the group’s underlying business ranks as one of the best in its peer group.
You see, for the next two years, BP is only planning to spend $20bn per annum of capital projects, which, according to City analysts, indicates that the company will be free cash flow positive by 2016, after the payment of dividends to investors.
This fact may not seem overly impressive at first glance, but it puts BP in an elite group. Many of the company’s peers are struggling to achieve this key goal of generating a positive free cash flow.
Additionally, BP has over 50 deepwater oil projects under development. These projects could produce an additional 900,000 barrels per day of oil equivalent production by the end of the decade, a fact that underlines BP’s growth potential.
Depressed valuation
Having said all of the above, BP’s current depressed valuation could be too hard for some opportunistic value investors to pass up. Specifically, on a per barrel of reserves basis, the company is the cheapest in the big oil sector.
However, due to the fact that BP’s earnings are set to collapse this year, tracking the falling price of oil, the company is currently trading at a forward P/E of 19.1, which looks expensive. But while the price of oil remains volatile, it makes sense to value BP according to its reserves, not earnings.
The bottom line
So overall, BP is primed for growth, undervalued and offers a hefty dividend yield of 5.9% but there are still plenty of risks facing the company. Further, BP’s future is linked to the price of oil. If oil rebounds, BP will surge ahead, but if the price of oil remains depressed, then the company’s performance will remain subdued.
With that in mind, BP may not the best pick for your ISA. The company is only suitable for those with a high risk tolerance.
