Savers who still believe cash can deliver more than decade after interest rates plunged to all-time lows need a reality check. Rates aren’t getting better. They might even get worse.
Cash is risky too
Australia, New Zealand, India and others have cut interest rates this year, and the US Federal Reserve is expected to follow suit in July. The European Central Bank and Bank of England are also turning dovish, and savings rates could even fall.
This puts a premium on top FTSE 100 stocks such as oil giant BP (LSE: BP), which are offering yields of 5% or 6%, and in some cases more. Naturally, shares are riskier than cash, as prices can fall as well as rise. However, while cash guarantees your capital it also guarantees the value of your money will steadily erode in real terms. For example, the average Cash ISA now offers around 1.3% while consumer price inflation stood at 1.9% in May.
BP currently yields around 5.8%, and that’s way above inflation. Buying its stock and reinvesting the dividends for 12 years would double your money even if the share price goes nowhere.
Double your money
The BP share price has picked since the Gulf of Mexico Deepwater Horizon sent it crashing to 325p in the summer of 2010, although the recovery has been slow and uncertain. When the oil price crashed to just $27 a barrel in January 2016 on fears of a shale-fuelled glut, BP crashed too.
Today, Brent crude trades at $64 a barrel. Some reckon it could soon top $80 as tensions between the US and Iran grow, although Russian energy minister Alexander Novak has just warned prices could still fall to $30 per barrel due to oversupply, if OPEC’s global oil deal is not extended in July. BP has positioned itself for whatever the oil price does next, targeting a low break-even price of about $40 a barrel to cover spending and dividends.
Climate change is another concern as a growing list of countries ban sales of new petrol and diesel cars, while Greenpeace protesters have been blockading BP’s London headquarters.
However, campaigners have been targeting BP for 20 or 30 years without inflicting serious damage on this money-making machine. Like it or not, the world still runs on oil. BP knows the dangers and is slowly (very slowly) positioning itself for a low carbon future.
The cash flows
At time of writing, the BP share price stands at 550p. It could hit 600p as lower operating costs, dwindling Deepwater litigation payouts, and steadier oil prices protect profit margins. However, its purchase of BHP’s shale assets has left it nursing hefty debts of $44.1bn.
BP still pumps out the cash, with operating cash flow standing at $5.9bn in the first quarter, while underlying replacement cost profit was $2.6bn. Much of this will make its way to shareholders, in the form of its dividend.
The biggest threat is the slowing global economy, which will inevitably hit demand for oil. Let’s hope lower interest rates could give us a soft landing. As I said, BP is not without risks. But the sooner you buy into the yield, the sooner you can start reinvesting those dividends, to pick up more stock and generate a long-term income for your retirement.
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Harvey Jones 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.