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I think smart investors should buy the BP share price when oil prices drop

The BP (LSE: BP) share price has been slipping over the past six months, giving up its early 2019 gains to stand just 0.5% ahead year-to-date, while the FTSE 100 has risen by nearly 10%. BP shares have essentially just been following the oil price, which peaked in April at around $75 per barrel, since when it’s been on a slide back to a current level of a little over $60.

The immediate question for me is why on Earth are investors in one of the world’s biggest oil companies, whose valuation depends on its long-term ability to deliver superior returns to shareholders, so hung up on daily changes in the price of a barrel? It seems wholly irrational to me, and I can’t help thinking that going against the market and buying BP shares during oil price dips should be a good long-term strategy.

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Previous lows

Looking back to the oil price dip in December 2018, BP shares fell to 481p at pretty much exactly the same time. If you’d managed to catch that low point, with the price now at 510p, you’d be 6% ahead — not a bad return in just over 10 months, especially with an expected 6.4% dividend yield to add to it.

Going back further to the oil price low of June 2017, BP shares at the time had dropped back a bit from their recent recovery following the oil price crisis and were trading at around 440p. If you’d bought then, you’d be sitting on a 16% gain and you’d have pocketed two years of dividends.

Crisis depths

And if we delve even deeper and go back to the depths of the oil price crisis around January 2016, when a barrel had slumped to less than $30, the BP share price crashed as low as 325p. Those who were canny enough to buy back then rather than running scared can now look back on a 57% gain plus three years of dividends (with another one not far off).

Now, what I’m not trying to say here is that we should all try to time our buys and sells to match the market’s ups and downs, because I’ve really never encountered anyone who has the ability to do that reliably in all my years of investing.

No, my point is that when shares move up and down in response to an underlying asset, the way BP shares clearly do in response to the oil price, we should have our eyes on the value of the shares, not on the price. That’s especially true when a stock is paying strong dividends, as a short-term dip in the share price can provide a significant long-term boost to the value of future dividends.

Future dividends

At today’s share price, the forecast 2019 dividend is set to yield 6.2%, and that’s great even as it is. But those who bought at 481p in December 2018 are on for an effective yield of 6.6% on their purchase price, buyers from June 2017 at 440p are set for a 7.2% effective yield, and the brave crisis investors from 2016 should reap a 9.7% effective yield.

So when oil prices fluctuate and BP shares gyrate in response, I say that instead of looking at the share price itself, look at the value of the future rewards you can buy at that price — one year, two years, five years ahead.

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Alan Oscroft 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.