BP (LSE: BP) shares may be slightly down in 2023 so far, but I can think of at least two reasons to hold them in my portfolio. Let me explain.
Cheap source of dividends
For me, BP’s appeal is two-fold. First, there’s the dividend yield of 4.6%, based on analyst projections. As things stand, that’s more than I’d get from buying a passive index fund that simply tracks the FTSE 100 (3.9%).
At this point, someone might argue that the tracker is a far safer option for income seekers because money is spread around a huge number of companies, rather than just one.
Fair enough. But it should be noted that BP’s forecast dividend looks likely to be covered at least three times by profits. Based on this, I’d be very surprised if this year’s expected payout didn’t materialise.
Second, the oil giant’s valuation remains low, at least relative to the UK market as a whole. In fact, a price-to-earnings (P/E) ratio of just above six makes BP one of the cheapest stocks in the index.
Value trap?
The trouble is that there are a few things about BP that niggle. There’s the dependence on a thriving global economy, for example.
Right now, there’s a whole lot of chatter about the possibility of a global recession. That would clearly be bad news for the oil price which has proved rather resilient to date.
As might be expected from a company that has high operating costs, BP also carries debt, and a lot of it. Companies with creaking balance sheets are generally not the sort I want to be holding in a crisis.
The long-term share performance also warrants attention. Excluding dividends, a £1,000 investment in BP shares five years ago would now be worth around £850. That’s surely ‘value trap’ form?
True, that paper loss might not be such a big deal for a retiree whose sole objective is receiving those payments every quarter.
But this brings me to another issue. BP’s record on dividends is far from perfect. Indeed, the income expected in 2023 is still way below pre-pandemic levels, due to a huge loss in 2020!
So that enticing dividend yield mentioned earlier isn’t necessarily all it’s cracked up to be.
Here’s what I’d buy instead
It isn’t too difficult to identify companies that I’d buy over BP shares.
FTSE 100 peers like Unilever, Diageo, BAE Systems and Bunzl easily make the grade from an income perspective. All possess far better records when it comes to paying out increasingly higher amounts of cash to their investors.
But life-saving technology firm Halma easily takes the top spot. It’s delivered dividend growth of 5%, or more, for the last… 44 years!
Yes, these firms carry debt and, no, none are completely immune from earnings cyclicality and share price wobbles. None have higher dividend yields than BP either.
There is no magic bullet in investing. However, all of the above boast consistently decent operating margins and returns on capital employed. These are both hallmarks of quality businesses — the sort that compound in value over time, growing investors’ wealth along the way.
As a long-term investor, I’d much rather own slices of companies offering a lovely mix of dividends and growth than BP shares any day.
