The Warren Buffett Bear Case For BP plc

Many investors who focus on a low price-to-earnings (P/E) ratio and high dividend yield in their search for value will have a hard time swallowing the maxim legendary investor Warren Buffett lives by: “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price”.

Today, I’m considering whether FTSE 100 oil major BP (LSE: BP) (NYSE: BP.US) is a wonderful company, and whether its shares are trading at a fair price.

A wonderful company?

Oil companies, with their vulnerability to cyclical demand and volatile prices, don’t leap out as obvious Buffett stocks. However, Buffett has been dabbling in oil shares in recent years.

In 2008, he confessed to the shareholders of his Berkshire Hathaway investment company: “Last year I made a major mistake … I bought a large amount of ConocoPhillips stock when oil and gas prices were near their peak”. He subsequently reduced the holding, though it remains a significant size.

Buffett also bought a stake in Exxon Mobil — during the third quarter of 2009 — only to sell the bulk of the shares just a few months later. His latest squeeze is Canadian oil sands producer Suncor.

What of BP? Well, I have to say that if Buffett viewed BP as a wonderful company, surely there was no better time to exercise his “be greedy when others are fearful” dictum than in the aftermath of BP’s disastrous oil spill in the Gulf of Mexico during 2010.

However, Buffett’s biographer Alice Schroeder said at the time she thought it unlikely he would take an interest. In an interview with Mac Greer on Motley Fool USA, Schroeder pointed out that:

“In distress situations, he has a very decided preference for not buying equity, but buying preferential securities where he has got the first preference and everyone else is subordinated to him in some way, or nearly everybody. Here, the people who are owed the claims for the damage have preference over everyone else …”

In addition to this situation still prevailing, I think BP’s significant exposure to Russia would be a concern for Buffett. He had some bad experiences of doing oil business in Russia during the 1990s — through one of Berkshire’s subsidiaries — and during 2006 he was still talking of Russia as a risk nightmare for western investors.

ConocoPhillips had a sizeable interest in Russia, but exited the country completely within a couple of years of Buffett investing. Exxon Mobil had no significant exposure to Russia at the time Buffett held the stock, and Suncor has no interests in the country.

A fair price?

BP strikes me as a fair company trading at, arguably, a wonderful price (single-digit P/E and dividend yield above 5%). But we know what Buffett thinks: “It’s far better to buy a wonderful company at a fair price”.

Buffet's big UK bet

Buffett rarely invests outside his home US market, but has backed one well-known UK business big-time. The multi-billionaire owns over 5% of this company's shares.

If you'd like to learn all about Buffett's big UK bet, you may wish to read this exclusive in-depth report. The report is 100% free and can be in your inbox in seconds - simply click here.

> G A Chester does not own any shares mentioned in this article.