Stating that BP (LSE: BP) could be the best investment opportunity on earth may seem like a rather unlikely assertion to make. After all, the oil price is standing at just under $50 per barrel and BP’s share price has fallen by 22% in the last year. However, this could prove to be the perfect moment to buy it for the long term.
A key reason for that is simple investment theory. As investors, we all wish to buy shares when they’re low and to sell them when they’re high. However, for a share price to be low in the first place, there must be a good reason for it. In other words shares don’t simply trade lower ‘just because’, but rather require some kind of uncertainty to do with the company, its industry or the wider economy in order to offer a wider margin of safety and more upside potential.
In BP’s case, the reason for its share price demise has mostly been external factors. For example, in recent years it has been hit hard by the Deepwater Horizon oil spill as well as sanctions against Russia, while the lower oil price has caused its profitability to come under severe pressure. Looking ahead, there’s scope for further pain if oil prices fall, although with BP having a sound balance sheet and strong asset base it should be able to outlast many of its smaller rivals if black gold were to trade far lower than its current price level.
Margin of safety
Evidence of the negative impact on BP’s valuation of the above factors can be seen in its price-to-earnings growth (PEG) ratio standing at just 0.1. That’s low because of BP’s share price fall, but also because it’s expected to bounce back with strong profit growth in the 2017 financial year. In fact, BP’s pre-tax profit is forecast to rise by over 100% next year and while this is highly dependent on the price of oil, BP still offers a wide margin of safety so that if the oil price does fall its shares could still offer major capital gains.
In terms of the outlook for the oil price, in the short run it may disappoint somewhat. That’s because the supply/demand imbalance that has largely been responsible for its weakness in recent months is set to continue over the short-to-medium term. However, in the long run, demand for oil from the emerging world in particular is likely to rise and when coupled with a potential supply constraint as investment in exploration falls due to a lower oil price in the short term, the prospect of $100-plus oil is relatively high.
So, while BP has been a poor performer of late and could record lacklustre performance in the coming months, for long-term investors it appears to have huge appeal.
