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I have a problem with these types of charts because the unit of measure used to compare oil against is being constantly devalued through inflation. Let’s therefore correct for that:
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With West Texas Intermediate Oil (WTI) for February delivery settling at $48.69 a barrel on the New York Mercantile Exchange the real oil price is certainly now below the trend line. It’s also 15% below the real average of $57.08 but it’s 7% above the real median price of $45.57. What do you think, is oil now over or under valued? Personally, I’m not even going to think about it because I’ve proven in the past that I’ll probably lose money if I do. What I do know is that the oil price change has had a big effect on the share price of Oil & Gas Producers like Shell and BP. It’s also had a big effect on Oil Equipment, Services & Distribution companies like AMEC Foster Wheeler and Petrofac.
The falling company prices have then caused BP to rise towards the top of my HYP watchlist of 136 companies. Subsequent analysis, which doesn't consider whether prices will rise or fall further in the short term, but is instead focused on purchasing high yielding shares for the long term, also looked interesting. This week I therefore pulled the buy trigger and added 1,131 shares to my HYP at a price of £3.9477.
Let’s review the key criteria in a little detail:
- The BP business model is very easy to understand and I’m sure nearly everyone knows what they do without research. They provide fuel, energy, lubricants and other petrochemical products for everyday items. They have their fingers in the pie from pulling crude oil out of the ground or sea all the way to the petrol station you might fill up from.
- I prefer large and non-cyclical industries. It’s certainly large with around 84,000 employees and some $380 billion in revenues. I do however acknowledge that it is very exposed to oil price changes which is what we’re seeing today.
- I already own Royal Dutch Shell, another Oil & Gas Producer, so I am breaking a rule here as I should have been adding a new industrial sector to my HYP. I've broken this rule previously when I added GSK when I already owned Astra Zeneca so I have form here. Today against my buy price GSK is underwater by 0.4% or £16 but a little in their defence they have paid me £116 in dividends since the purchase.
- I'm looking for shares with dividend yields somewhere between the current FTSE 100 yield of about 3.5% and 1.5 times the FTSE 100 yield or 5.3%. On a trailing yield of 5.9% BP is therefore a little over the top. Forecast dividend is currently even higher at 6.3%.
- The company should have an unbroken history of continually increasing dividends plus dividends that increase at a rate equal to or greater than inflation. The Deepwater Horizon oil spill in the Gulf of Mexico which started on the 20 April 2010 saw the dividend more than halved from $0.56 to $0.21 per share. However, in the 4 years since the disaster dividends have increased year on year and are now up by a total of 76% to $0.37. This is significantly above inflation.
- A dividend cover of greater than 1.5 for all HYP type shares except utilities where I think that greater than 1.25 is ok. Here BP passes with flying colours sitting on 3.3.
- ‘Creative accounting’ can make earnings and hence dividend cover look good. I therefore also set a greater than or equal to 2 criteria on Operating Cash Flows compared to Dividends. At 3.0 this also looks pretty healthy.
So I've doubled up on sectors, BP doesn't have an unblemished dividend history, the high dividend yield is a little over the top and I'm sure oil prices are going to hit profits in the short term. That said I'm not buying for the short term but rather with a fair wind for the rest of my life. Is BP a contrarian play – with the Brokers surveyed by Digital Look suggesting a Strong Buy certainly not. Is it a foolish play – well only time will tell on that one. Is it a mechanical play based on my long ago selected criteria – yep it’s pretty close to one of those.
As always DYOR.
- US inflation data for December 2014 and January 2015 is estimated.