While the oil sector may not be the most popular place to invest at the present time, there is huge potential to make capital gains. Of course, it may take time for companies such as BP (LSE: BP) (NYSE: BP.US) and Wood Group (LSE: WG) to come good but, for investors taking a long-term view and who can accept a degree of volatility in the short run, gains of over 20% seem to be very achievable.
A key reason for that is the valuations currently on offer within the sector. After a year in which the price of oil more than halved, it is not surprising that major share price falls have been recorded. For example, BP saw its share price slump from 520p in July 2014 to as low as 385p in December of the same year. That’s a fall of 26% in just five months and, likewise, Wood Group recorded a decline of over 20% in its valuation during the same time period.
As a result, both stocks now trade on very appealing valuations. Certainly, their share prices have stabilised somewhat since then, but BP still has a forward price to earnings (P/E) ratio of only 13.3 (using 2016’s forecast numbers). Similarly, Wood Group has a forward P/E ratio of just 12.5, which indicates that its shares could be due for a significant upward rerating over the medium to long term.
Clearly, the performance of both companies has been affected by the falling oil price, but their earnings numbers are perhaps better than many investors may be anticipating. For example, BP is forecast to grow its bottom line by 98% this year and by a further 20% next year, while Wood Group’s bottom line is expected to post a fall in earnings of just 6% this year and a further 5% next year.
Certainly, in BP’s case its net profit is still set to be over a third lower than it was in 2014 but, given the challenging trading conditions, its improving performance and Wood Group’s relatively stable numbers could lead investors to decide that the two stocks are worthy of an upward rerating.
In fact, if BP and Wood Group were to see their P/E ratios increase by 20%, it would still leave them trading on relatively appealing valuations. In BP’s case, it would mean a P/E ratio of 16, while Wood Group would have a P/E ratio of 15, and would equate to share price gains of more than 20% in both cases. And, with BP having a price to earnings growth (PEG) ratio of just 0.6 and Wood Group’s price to book (P/B) ratio being a rather modest 1.3, a 20% gain in their share prices appears to be very realistic.
Certainly, the oil price may endure a number of challenging months and may test its recent lows. As such, BP and Wood Group are likely to remain relatively volatile but, with relatively strong financial performance set to be delivered, they both appear to present a favourable risk/reward opportunity, having the capability of rising by 20% or more over the medium term.
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Peter Stephens owns shares of BP. 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.