BP (LSE: BP) shares have tumbled 31% from their 30 April 12-month traded high of £5.29. As a stock’s yield rises when its price falls – provided the annual dividend remains unchanged, which is not guaranteed – it is now returning 6.6%!
By comparison, the average FTSE 100 yield is 3.6%. It is also within a whisker of my minimum 7% annual yield requirement for my passive income stock portfolio.
This comprises shares that generate a very high yearly income for me with very little effort on my part. The aim of this portfolio is to allow me to keep reducing my working commitments as I grow older.
Aside from the boost to BP’s yield, its share price fall has left the stock looking undervalued to me. That said, a risk here remains long-term bearishness in oil and gas prices.
How undervalued are the shares?
I always start my price assessment for stocks by comparing key value measurements with its competitors. Value and price are not the same thing and spotting the difference between the two is where the big profits lie, in my experience.
So, BP’s 0.4 price-to-sales ratio is bottom of its peer group, which averages 1.7. These firms comprise Shell at 0.7, Chevron at 1.2, ExxonMobil at 1.4, and Saudi Aramco at 3.5.
Therefore, BP looks extremely undervalued on this basis.
The second part of my price assessment focuses on where any stock should be priced based on the cash flow forecasts for the firm.
The discounted cash flow analysis for BP shows its shares are 71% undervalued at their current £3.64 price.
Consequently, their fair value is technically £12.55. Although share price movements are unpredictable, this underlines to me how exceptionally undervalued the stock looks.
What’s the yield outlook from here?
Consensus analysts’ forecasts are that BP’s dividend will rise to 24.7p in 2025, 25.8p in 2026, and 26.9p in 2027.
Based on the current share price, these would generate respective yields of 6.8%, 7.1%, and 7.4%.
However, using just the current 6.6% yield would mean investors considering a holding of £11,000 — the average UK savings — in the firm would make £726 in first-year dividends.
This would rise after 10 years on the same average 6.6% yield to £7,260. And it would increase after 30 years on the same basis to £21,780.
The miracle of compounding!
That said, much greater returns could be made using ‘dividend compounding’. This involves reinvesting the dividends paid by a stock straight back into it. It is a similar idea to leaving interest to gradually accrue in a bank savings account over time.
Using this method with the same 6.6% average yield on the same £11,000 stake would make £10,244 in dividends not £7,260 after 10 years. And after 30 years of doing the same this would increase to £68,239 rather than £21,780.
Adding in the initial £11,000 stake and the total value of the BP holding would be £79,239. And this would be paying £5,230 a year in dividends by that point!
Will I buy more of the shares?
It is ultimately a firm’s earnings growth that drives its dividend and share price higher. In BP’s case, analysts forecast its earnings will increase 27.9% a year to the end of 2027.
Given this, I will buy more of the stock very soon.
