Are BP shares a bargain after a 15% fall?

There are signs BP shares are cheap right now. But investors need to be aware of the risks associated with oil stocks, says Edward Sheldon.

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BP (LSE: BP.) shares have taken a hit. Around two months ago, they were trading near 540p. Today however, they’re near 460p – about 15% lower.

Are they now a bargain after this double-digit share price fall? Let’s discuss.

Three signs there’s value on offer

Looking at the oil powerhouse today, there are definitely some factors that indicate its shares are cheap. Let’s start with the price-to-earnings (P/E) ratio (a valuation metric that allows us to easily compare different companies’ valuations).

Currently, BP has a P/E ratio of just seven. By contrast, US oil giants Chevron and Exxon have ratios of 12. This discount suggests BP’s undervalued right now.

Another valuation metric that suggests the shares are cheap is the free cash flow yield (the amount of cash a company generates after taking into consideration cash outflows to support its operations and maintain its assets).

Last year, BP generated free cash flow of 100 cents per share. At today’s share price, that puts the free cash flow yield at about 17%. That’s really high, which indicates the shares are in bargain territory at present.

One other factor that’s worth highlighting here (and this is less technical) is that famous value investor Michael Burry – who made a killing betting against the US housing market before the Global Financial Crisis of 2008/2009 – has been buying BP shares this year.

I don’t know if Burry (whose character appeared in the Hollywood blockbuster The Big Short) has been buying into the recent dip. But 13F regulatory filings show he was definitely buying BP shares in the first quarter of 2024, when the share price was at similar levels to today’s price.

Oil prices add uncertainty

Of course, the problem with oil stocks is that they’re a slave to oil prices. If they were to fall from here, I’d expect BP’s share price to fall too.

After pulling back between mid-April and early June, due to concerns about global economic growth and rising US stockpiles, oil prices have rebounded in the last week or so. However, we can’t rule out further weakness in the months ahead.

It’s worth noting that analysts at Citi believe the price of Brent crude oil could fall to $74 a barrel by the end of 2024 and $55 a barrel by the end of 2025 (from around $80 a barrel now) due to surplus inventories. Analysts’ forecasts are often off the mark (especially for commodities like oil). However, if these forecasts turn out to be accurate, BP shares could underperform.

Cheap, but not for me

Given the unpredictable nature of oil stocks, I’m unlikely to buy BP shares for my own portfolio any time soon.

However, my gut feeling is that they’re cheap today. If I was a value investor, I might consider buying them.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Edward Sheldon 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.

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