A bumper year of earnings for British oil giant BP (LSE: BP) has made the stock look astoundingly cheap.
One measure, the price-to-earnings ratio, is now only 4.5 for the company. That looks like a bargain compared to the trailing 12 months P/E ratio of the FTSE 100 of around 14 and the 10-year Footsie average of 19.
That means, compared to other UK-based firms, the company is generating a lot of profit for the 535p it would cost me to buy a share.
Based on this, now could be a rare chance for me to buy into one of the cheapest stocks on the FTSE 100.
A sideways stock
I see three reasons why this stock looks cheap that can help me work out if I should buy some shares.
First, BP is what some call a ‘sideways stock’. That’s a name given to a company whose share price doesn’t go up or down much over long periods.
I think the term is suitable for the oil firm over the last couple of decades as the following graph shows.
The reason this lack of growth is a problem is that if I held a stock like this then I’d have to rely on dividend payouts to get a return on my investment.
As I mentioned, BP’s current dividend yield is 3.92% for the year. That’s not awful, but a lot of investors would say 4% is a mediocre return which could drive the share price down.
A banner year
Second, BP’s current P/E ratio uses earnings from the last 12 months. While the 2022 profits of £28bn are impressive, the profits from 2021 were only £13bn.
The reason for the high 2022 figure is the recent boom in oil prices which surpassed $120 a barrel at their peak.
I suspect this was a temporary boost, and the fact that the current price for a barrel is already down to below $80 makes me think I’m right.
As such, the stock only seems extremely cheap looking at the last 12 months. And actually, the P/E ratio at the end of 2021 was at 11.8, which makes the stock seem less of a no-brainer buy.
The long term
Finally, another factor that makes BP look cheap is its future prospects. Oil and gas companies are similar to tobacco companies in that the products they sell have an uncertain future.
The oil behemoth does have an interest in what it hopes are future-proof renewables, making a $356m investment in low-carbon projects in the first half of 2022. However, over the same period, it invested $4.5bn in oil and gas projects.
Spending 12 times more on oil projects than renewables tells me where the focus for the firm is. So even if the stock does look cheap, I’d be concerned about what the share price would do over the long term.
Taken together, I believe these three reasons explain why I won’t buy shares in the firm right now despite its cheap valuation.
