Falling oil prices have sent shares in BP (LSE:BP) to a 52-week low. With the stock trading at a forward price-to-earnings (P/E) ratio of 7, shares in the FTSE 100 oil major look like a bargain.
Things aren’t entirely straightforward, though. Investors need to think a bit more carefully before deciding whether or not to jump into the stock.
Cyclicality
By almost any standard, a P/E multiple of 7 is low. And it’s natural to think that it offers a margin of safety – even if earnings halve, a 14 P/E still isn’t exactly expensive, right?
That might be a reasonable way to think about some businesses, but BP isn’t one of them. The company’s earnings can be extremely cyclical as oil prices fluctuate.
BP earnings per share 2014-23
Created at TradingView
In any given year, BP’s earnings are capable of falling by much more than 50%. In fact, this has happened five times since 2014.
As a result, I’d be very reluctant to think a P/E ratio of 7 provides any sort of protection. While profits halving might not be a disaster, investors need to be prepared for much worse.
How to think about BP shares
Volatile earnings mean the P/E ratio is a bad way of valuing BP shares. But the company’s book value – the difference between its assets and its liabilities – is much more stable.
So I think the price-to-book (P/B) ratio provides a better way of thinking about how cheap the stock is. And the picture this presents is an interesting one.
BP price-to-book ratio 2014-24
Created at TradingView
At around 1.2 times book value, the stock is certainly cheap compared to where it has been over the last couple of years. But it’s not at historically low levels or anything like that.
It might well be the case that BP is at a cyclical low at the moment. But that certainly doesn’t mean it can’t go lower from here. And of course, it can go higher too and be a great investment for those who bought it cheaply.
Outlook
It’s been a difficult few years for BP shareholders. The company has found itself in the wrong place at the wrong time recently.
Investing heavily in renewables resulted in losses as inflation and rising interest rates made projects unviable. And the switch back to oil has been met with a fall in prices.
However, BP is showing signs of improving its long-term position. The firm has managed to reduce its breakeven cost to around $50 per barrel, with new projects profitable above $40.
The company can’t do much about the price of oil. The biggest thing it can do is try to keep its own costs down and it does look to be doing an impressive job of this at the moment.
Are BP shares a bargain?
If someone was considering BP shares on the basis of the company’s ability to extract oil at competitive prices, I probably wouldn’t object. But I don’t think the stock is unusually cheap.
A P/E ratio of 7 looks like it offers some margin of safety. In the volatile world of oil stocks, however, investors need to be more careful.
