Looking back, BP (LSE: BP) shares were a steal in October 2020 when they briefly dipped below 200p.
But investors needed contrarian nerves of steel to buy the stock back then. We were in the grip of the pandemic and lockdowns. The price of oil was on the floor. And BP looked more like a basket case than I can ever remember. It seemed that profits would be a thing of the past. No wonder the shares got dumped on the stock market.
A great contrarian play
However, cool-headed value investors and contrarian-minded thinkers were all over the stock. The extraordinary circumstances of the day were of a temporary nature, right? And profits would surely return to the business as sure as day follows night. The inevitable consequence would likely be a recovering share price.
Yet, my guess is those investors who actually bought the stock back then would be amazed at just how right they’ve proved to be. Of course, the war in Ukraine was a big booster for the price of oil, which most of them probably didn’t foresee.
But last year’s bumper profits for the oil companies drove the BP share price way higher than it might otherwise have travelled without the war. As I write, it sits near 558p. And it has delivered shareholders a capital return of about 180% since those dark autumn days of 2020. But there’s been dividend income on top of that.
I’d say BP has been an exemplar for how a contrarian investment strategy can work for investors when things click. Even over the past year alone the stock has risen by 50%. But here’s the thing, the valuation doesn’t look stretched. And that’s unusual. Often when share prices lock into an enduring uptrend, the move takes valuations higher. And they often move way beyond a fair price.
Is it cheap, or what?
But the forward-looking earnings multiple for 2024 is only around 6.7. And the anticipated dividend yield is just above 4%. Meanwhile, BP has been using its cash flow windfall to pay down some of its debts. And that’s been building up the value attractions of the business even more.
So, by traditional valuation measures, BP shares look like a steal right now. But would I be bonkers to buy them after such a strong rise? Maybe. Let’s not forget how fast the company’s fortunes changed near the cyclical bottom in 2020. It’s as if everything turned on a handbrake. And that could happen near the top of a cycle in the other direction. All it would take would be a plunging oil price and shareholders would need to hold onto their hats. Indeed, the share price would likely plummet at speed as profits fell away again.
But the recent outlook statement is surprisingly robust. And City analysts have only pencilled in a mid-single-digit percentage decrease in earnings for 2024.
Nevertheless, I don’t see the low-looking valuation in itself as reason to buy the stock. Cyclical businesses are ‘supposed’ to trade at low multiples after a period of high profits. So I rate BP as cheap right now. But it wouldn’t be bonkers to buy either. However, I’d be inclined to keep the stock on a short leash. And I’d keep an eye open for signs of the next downturn if I did buy.
