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Lindley Estes is a business writer for The Free Lance-Star and Fredericksburg.com. This blog is on Fredericksburg-area business. Send an e-mail to Lindley Estes.
This week’s (6/6) investing column
THE CASE of BP’s beleaguered stock illustrates the difficulty of being a value-oriented investor.
Value investors look for beaten-down stocks that in their opinion have been unfairly punished for various reasons–earnings misses, negative headlines, investor misconceptions and more.
In many respects, BP is a value investor’s dream. The stock price of the London-based energy company has plummeted about 40 percent following an April 20 oil rig explosion in the Gulf of Mexico that killed 11 people and caused unknown millions of gallons of crude to gush into the waters and onto nearby coastlines as BP struggles to stop the flow.
That stock decline has shaved about $70 billion of value off BP’s market cap. The stock fell 15 percent on Tuesday alone following word that the U.S. attorney general’s office may launch a criminal case against the oil company.
The sharp drop has created a possible bullish case for BP stock. As of mid-week, the company’s price-to-earnings ratio was under six. It sported a 9 percent dividend yield, nearly triple the rate on 10-year U.S. Treasurys. The company’s CEO on Wednesday said the dividend was secure, and that total disaster-related charges wouldn’t exceed a few billion dollars–a far cry from the $70 billion investors have lopped off the market cap.
But investing in BP requires a strong stomach, as is usually the case for value investors.
BP isn’t exactly a company that many people would want to be associated with right now. You’re probably not going to get too many pats on the back if you regale fellow cocktail-party guests with tales of snapping up BP stock on the cheap.
Further, who’s to say the stock really is that cheap? The market usually has a good eye for spotting unsustainable dividend yields, and BP’s 9 percent payout could be an example of that. It’s impossible to know how long the oil will keep flowing from the well, what BP’s ultimate liability will be, whether there will be criminal charges, what this means for the future of offshore drilling, and more. Without knowing those variables, it’s difficult to calculate a value for the company.
But that’s the kind of tough decision that value investors ultimately have to make. They must weigh the downside risks with the upside potential. They must be willing to consider companies that most wouldn’t touch with a 10-foot poll, and have conviction in their independent analysis.
None of that is easy to do. It’s much simpler to join the herd in bailing out on BP than to stick out your neck and bet on the company’s ability to weather this firestorm.
And that’s why true value investors are a rare breed.