Legendary growth investor Jim Slater once said that elephants don’t gallop. This was why he preferred to invest in smaller companies.
Mr Slater was right. But for most of us, who have limited time to research and manage our investments, I think it makes sense to hold a mixture of reliable elephants and smaller, more exciting stocks.
An elephant I’d buy
BP (LSE: BP) is a good example of the kind of elephant I like to own. The shares are unlikely to double. But in recent years, the company has shown how investors can benefit from investing in elephants.
The huge financial impact of the 2010 Deepwater Horizon disaster was followed by the 2015/16 oil market crash, which saw oil prices drop below $30 per barrel at one point. Despite these pressures, BP only missed three quarterly dividends in 2010 and didn’t cut its payment at all in 2015/16.
Today, the company has restructured its operations to be profitable at lower oil prices and is starting to focus on debt reduction.
Analysts expect BP to report underlying earnings of $0.53 per share for 2019 and pay a dividend of $0.40 per share. Although earnings cover for the dividend looks fairly slim, cash generation has improved over the last couple of years. I expect this payout to remain safe.
These forecasts price BP shares on 12 times forecast earnings, with a dividend yield of 6.4%. I rate this FTSE 100 giant highly as an income buy. But I don’t expect too much in the way of growth. For that, I think we need to look elsewhere.
This small-cap yields 9%
The next company I’m going to look at is SOCO International (LSE: SIA). This £250m oil and gas producer operates in the waters off the coast of Vietnam and at onshore oil fields in Egypt.
At the time of writing, SOCO shares offer a dividend yield of 9%. Such a high yield normally means that the shares are too cheap, or that a dividend cut is likely.
Personally, I think this stock could turn out to be a serious bargain at current levels. Group production is expected to reach about 13,000 barrels per day by the end of 2019. Production costs are low, at less than $10 per barrel. Historically, this has enabled the group to generate very high levels of free cash flow.
Using this week’s half-year accounts, my sums suggest that SOCO shares trade on just six times underlying free cash flow from the last 12 months. If this level of cash generation can be maintained, then I think the dividend should be safe. The payout might even rise.
At a last-seen price of 65p, these shares also trade at a 37% discount to the firm’s net tangible asset value of 103p per share.
This looks like a bargain. What’s the catch?
The main problem seems to be that growth has been limited in recent years and CEO Ed Story’s strategy is unclear. Is the business, which Mr Story founded, heading for a long-term decline?
A strategy day is being planned for City analysts in October. Hopefully we’ll find out more then. Until that time, I continue to feel that SOCO is a potential bargain for small cap investors.