What is going on with the BP (LSE: BP) share price? That’s a question I’ve been considering based on the stock’s recent performance.
Over the past 12 months, shares in the company have returned -4%, excluding dividends. However, over the same time frame, the price of oil has returned more than 200%.
As one of the world’s largest oil producers, BP will undoubtedly benefit from being able to sell its output at higher prices. Unfortunately, the company’s current stock price does not seem to reflect this improved outlook.
The question is why? Is this an opportunity I can take advantage of to earn a profit?
BP share price valuation
BP is clearly set to benefit from higher oil prices.
According to City analysts, the group’s earnings per share could grow as much as 29% this year on the back of higher oil prices.
And if the price of oil remains at current levels, analysts believe the company’s earnings per share could grow a further 13% in 2022.
While these are just estimates at this stage and could be subject to change, I think the figures show its potential. BP’s profits should grow as the global economy moves on from the pandemic and demand for oil returns to pre-crisis levels.
Based on these numbers, the BP share price is dealing at a forward P/E of 9.7 for 2021, potentially falling to 8.5 for 2022. That appears to me to be incredibly cheap, mainly because the rest of the market is trading at a P/E of around 15.
As well as this valuation, the stock also has the potential to offer a dividend yield of 4.8%, according to analysts.
Risks and challenges
While the BP share price does look cheap compared to its potential, it’s unlikely to be plain sailing for the group over the next few years. The pandemic is not over yet. Another outbreak could set the global economic recovery back months or years.
There’s also a chance the oil market’s most prominent producers, which cut production last year to stabilise the market, could increase output due to higher prices. This would hurt other producers like BP as the price of oil would likely fall.
As these risks continue to hang over the BP share price, I can see why investors have been avoiding the business. There’s a lot of uncertainty surrounding the outlook for the enterprise, and trying to understand where the company could be five years from now is incredibly challenging. As such, the investment is unlikely to be suitable for risk-averse investors.
Still, I would buy shares in the oil company today as a recovery play, despite these risks.
Yes, BP is facing an uncertain future, but the stock’s current valuation suggests that the shares are undervalued if the business can return to growth in the next two or three years.
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Rupert Hargreaves has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.