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Are BP plc And Enquest Plc The Perfect Partnership For Your Portfolio?

Enquest (LSE: ENQ) is one of the market’s most promising exploration and production oil companies. The company’s shares could turn out to be a multi-bagger over time.

However, in the oil sector nothing’s certain, and, as a relatively small oil company, Enquest is still a risky pick. 

A basket approach 

The best way to reduce risk when investing in small-cap oil cos like Enquest is to use a basket approach.

Simply put, a basket approach combines high-risk growth stocks, with low-risk, large-cap income stocks. This approach gives your portfolio a degree of stability and a regular income while also allowing you to benefit from capital growth.

And the best company to accompany Enquest in a basket portfolio is BP (LSE: BP) 

Income champion 

BP is an income champion and currently supports a dividend yield of 5.5%. The payout is set to increase by around 5% next year, which should give the company’s shares a yield of 5.7%. 

Unlike Enquest, BP is an integrated oil company and can profit when the price of oil is both rising and falling. On that basis, the company’s dividend payout is relatively safe for the time being.

On the other hand, as a plain vanilla E&P company, Enquest’s profits are highly sensitive to the price of oil.

For example, City analysts expect the company’s earnings per share to drop by a staggering 87% this year as high production costs and the weak oil price squeeze margins. BP’s earnings are expected to rise by around 80% this year.

Multi-bagger

Last year Enquest reported earnings per share of 11.3p. If the price of oil returns to its 2014 high of $110, there’s no reason why the company’s earnings can’t return to their 2014 high as well.

Moreover, if Enquest’s valuation were to return to its historic average of 12 times earnings, on earnings per share of 11.3p, the company’s shares could be worth 136p — 142% above current levels. 

But this is only a hypothetical situation, and no one can be sure when the price of oil will return to its 2014 high. 

That’s why a basket approach is your best bet.

Risk reward

A £1,000 basket split equally between BP and Enquest would yield around 2.7% per year.

If Enquest’s shares returned to 136p, the value of the Enquest holding would rise to £1,214 and the portfolio’s overall value would rise by 72%. Of course, there’s also the potential for capital growth with BP as well.

The most important thing to remember with a basket approach is that it limits your downside. If Enquest does go under, the basket portfolio will lose around 50% of its value, which is a big hit.

Nevertheless, the remaining BP holding will continue to produce income, and over time, you will be able to recoup your losses. Without using the basket approach, there’s a chance you could lose everything.    

The best way

A basket approach is the best way to profit from high-risk companies without losing your shirt. And BP isn't the only company out there that would make a great income 'backbone' for your basket portfolio. 

To help you build your dividend portfolio, the Motley Fool's top analysts have put together this free report revealing the secrets on how you can "Create Dividends For Life".

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Rupert Hargreaves 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.