The Peril Of Holding Onto BP plc & Tesco PLC

BP plc (LON: BP) and Tesco PLC (LON: TSCO) are attractive investments at their current valuations, argues this Fool.

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Albert Einstein once said that you should not try to become a man of success, but rather you should try and become a man of value. 

How does this apply to such big corporations such as BP (LSE: BP) and Tesco (LSE: TSCO)? 

Exact Science?

Einstein also argued in favour of compound interest, calling it “the most powerful force in the universe“. 

So, we must delve into the dividend prospects of BP and Tesco to determine whether they could deliver capital gains and annual dividends that could be reinvested into their shares.

Tesco won’t pay much this year — its forward yield is very close to zero and is unlikely to rise over the next 12 months. Let’s move on to BP, whose stock offers a forward yield at 8%.

Consensus

Analysts are divided on BP’s future — some argue that its forward yield must fall, while others are less downbeat. Well, I am very bullish on BP.

Analysts at commodity house Royal Bank of Canada met Anthony Harbridge, director of investor relations of BP, on Tuesday. “The mantra of ‘lower for longer’ has led BP to cut capex more than peers in 2015 with a cut to ‘below $20bn’, and Anthony also signalled that 2016 could be below this year’s spending,” they wrote on Wednesday. 

All good so far. 

They added: “Dividends remain paramount in BP’s financial framework, and with the cost deflation coming through (with a 12-18 month lag on oil prices), BP expects to balance the financial framework (operating cash flow = capex + dividends) by around end 2016 at an oil price around $60/bbl.

This is music to my ears.

Yield Down To 6% = 36% upside 

Time and again I have argued that BP can easily take on more debt to finance its dividend, or simply it may use part of its cash pile to finance a rich payout. 

Either way, its current forward yield of 8% will have to fall at some point: a drop to a more reasonable 5.5%-6% level will likely come on the back of a stock price rally that could make you rich in a flash, in my view. 

Consider that if I am right — and assuming constant dividends per share at 40 cents annually — that kind of drop in its yield would imply pre-tax gains of at least 36.3% from BP’s current level. 

Disappointment 

The food retailer is neither a yield play nor a growth story but its restructuring remains appealing and its current share price of 170p a share indicates that it could be time to pull the trigger. If trading profit remains within estimates, I doubt a cash call will be required — yet that risk is implicit in Tesco’s current stock price, in my view.

I am closely monitoring its trading profit, and you should do the same over the next couple of weeks. Its interim results are due on 7 October, and there’s a chance that if you buy its stock right now at 170p then you could record a very nice capital gain over the medium term.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Alessandro Pasetti has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

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