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21.9 Reasons To Buy BP plc And Sell BG Group plc

Shares in BP (LSE: BP) (NYSE: BP.US) have fallen by 20% over the last year, while BG Group (LSE: BG) has lost 36% of its market capitalisation.

However, a big fall in a company’s share price doesn’t always make it cheap.

What’s more, although these falls have been painful for shareholders, they are really just short-term fluctuations in the valuation of long-term businesses.

As investors, we need a more reliable way to identify genuinely cheap buying opportunities.

One such method is the PE10 ratio, which divides the current share price by a firm’s ten-year average earnings per share.

The result shows how the company is valued against its earning power over a significant period of time. That’s very useful, especially with oil and gas companies, whose profits can be very volatile from year to year, as the price of oil and gas fluctuates.

BP vs BG

I’ve calculated a PE10 value for BP and BG — the results may surprise you:

Company

PE10

BP

7.0

BG

14.9

Source: company reports

BG Group is valued at almost 15 times its ten-year average earnings, while BP trades on just seven times ten-year average earnings per share.

A growth investor might say that this is because BP is shrinking, having sold nearly $50bn of assets to fund the costs of the Gulf of Mexico disaster, while BG Group is a growth story that’s about to start generating lots of cash.

Perhaps, but I’m not convinced — and here’s why.

There’s already a lot of bad news priced into BP shares. Take your pick — BP is expected to report a loss from its 19.75% stake in Rosneft, the firm’s generous dividend might be cut, and it could face a $20bn fine in the US this year.

Good news is thin on the ground for BP shareholders.

At BG, on the other hand, the market is still quite optimistic. BG shares currently trade on 15 times 2015 forecast earnings — compared to 10 for BP.

BG recently reported the first shipment of gas from its Australian QCLNG project, and it’s secured the services of Statoil’s highly-rated chief executive, Helge Lund, who will start work at BG in March.

Yet BG isn’t without problems: it’s got too much debt, and has also been hit by the falling price of oil.

What’s more, after a turbulent few years, it would be surprising if Mr Lund didn’t find a few more skeletons in the firm’s cupboards when he takes control, which could lead to a painful kitchen sink update soon after he starts work.

As a result of all this, I believe BP is a buy, but BG Group remains a sell.

Of course, you may not agree. But whether you share my view or not, I'd urge you to consider the five stage dividend test in "How To Create Dividends For Life".

Applying these rules to your dividend stock picks could help you avoid painful losses and outperform the wider market.

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Roland Head has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.