The huge 6% dividend yield on offer at BP (LSE: BP) is bound to attract the attention of many income-seeking investors. And I also think that the oil company’s well-known name and sheer size will put the share on many watch lists. Indeed, the £106bn market capitalisation makes BP one of the largest enterprises in the FTSE 100.
Are big-caps less risky?
I reckon some feel that big, well-established firms are less risky than smaller ones. And I agree that with big-caps we are unlikely to see the rapid share-price rises and plunges that some micro-caps deliver. Sometimes shares of small firms move so fast that it’s impossible to react with buying and selling the stock before the move is done. With big-caps, on the other hand, large moves in the shares can happen, but usually over a longer time frame. So we often have the opportunity to trade along the way if we want to.
However, big-caps are still capable of delivering substantial risk. Look what happened to BP when the Macondo well blew out in the Gulf of Mexico back in 2010. The share price more than halved, the dividend became toast and the firm has been paying the bill for the disaster ever since. Unforeseen things can happen to the operations of any company, no matter how large it might be. But I think in the case of BP it’s worth remembering how dangerous its operations can be, even though the firm works hard to mitigate the risks it faces.
Will BP returns outperform the market?
If you own shares in a company such as BP, you are aligned with the risks the firm takes on in its daily operations. You will be exposed to single-company risk and your entire investment could plunge in value if the company hits a spot of bother. That’s why I believe that it only makes sense to invest in individual companies if you have a strong conviction that the total returns from your investment will likely outperform returns from the stock market in general. If you don’t have such a conviction, what is the point of spending all the time researching and managing your single-company investment when you could simply invest in a low cost, passive index tracker fund such as one that follows the FTSE 100?
Indeed, the long-term performance from a tracker fund can take some beating, and it certainly is a low-hassle way to invest. But I can see why some would be tempted by BP’s big dividend. After all, dividend investing is a popular strategy and compounding the income you get from dividend shares can add up to big returns over time. But if I had an income portfolio I wouldn’t choose BP. What bothers me is the firm’s cyclicality. Time and again the firm has shown how responsive it is to the price of oil, and I reckon its cyclicality is one reason why the company has struggled to raise its dividend each year. So I’d ignore BP’s 6% dividend yield and seek my income investments elsewhere or invest in a FTSE 100 index tracker fund instead.
Kevin Godbold has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.