Imagine, for a moment, that we could go back in time to 2010 when BP was trading at $43 per share before the oil spill. Someone who considered the stock would have a seen a vast oil conglomerate with a 5% dividend yield that had a multi-decade track record of increasing the dividend over every five-year rolling period. If you wanted high current income, BP was exactly the kind of company you would want to own. It had a dominant franchise, a strong history, and the financials appeared to be trending upward.
The five-year period that followed was far worse than what a garden variety cynic would predict. There was the disastrous oil spill that cost BP north of $20+ billion in cumulative costs. In response, BP had to cut its dividend and sell off a fifth of its assets. Then, a previously lucrative partnership grew shaky in the midst of Russian nationalization threats and nearly extortionate costs associated with the partnership. And finally, the price of the commodity fell by over 50% during the current measuring period that we are considering.
It is hard for things to get much worse than that: sales of over one-fifth of the production facilities, the item being produced fell by 50%, and a huge sinkhole of costs that weren’t able to be put to productive use. Happy days for the core business were not here, to say the least.
And yet, one fact remained: even after all the losses, BP was still pumping out 1.7 million barrels of oil per day. This oil, even at the worst of it, was produced at a profit. Even with oil trading at $48 per barrel, BP was still able to make a profit because it costs $36.80 for BP to produce each barrel that it takes to market. As long as oil remains above $36.80, BP remains a profitable enterprise.
When a company produces 625 million barrels of oil per year, and it makes around $11.20 or so per barrel even in a weak energy world, the investors still get to generate $7 billion in annual profits on their behalf. It puts the current dividend payout of $7.2 billion at risk, but the health of the enterprise itself is fine even at these low prices.
Although it may not feel like it, BP is a money-printing machine. Collectively, the shareholders are part of an enterprise that is making $20 million in actual profits every single day while oil remains this low. The only real manifestation of this greatness has been the dividend these past five years. Shareholders received $1.68 in 2011, $1.98 in 2012, $2.19 in 2013, $2.34 in 2014, and $2.40 in 2015.
In those five years of holding the stock, you would have collected $10.59 in cash for each share of BP that you held. If you got your hands on BP at $43, you would have collected 24.6% of your initial investment amount back in the form of dividends in just five years. It also means that as long as the price remains at $32.41 or above, you would have broken even on your investment since before the oil spill.
If you purchased 1,000 shares of BP before the oil spill for $43,000, you would have received a total of $10,590 in dividends and the holding would be worth $34,400. It is that later value–the $34,400–that stock market participants and pundits usually make the objective of disproportionate focus. Yet that $1 in dividend payments is just as real as a dollar in executed capital gains. Your $43,000 investment would have a value of $44,990.
My example is both overstated and understated. To figure out the true purchasing power change of your investment, you also need to calculate the inflation rate for which you live. To keep up with inflation, you would need the value to be around $49,800 if your inflation rate is 3.3%.
On the other hand, the figure may be understated because I assumed that each dividend payment remained dormant as cash. When BP paid $0.42 for each share in the first quarter of 2011, our investor would have done something with that $420 check. It could have been put into additional shares of BP, or used to make another productive investment altogether.
Does anyone make an investment with the hope of breaking even five years down the line? No, of course not. But what I do hope to teach you is that risk can be minimized in the event that reality disappoints. The greatest concept of them all is Benjamin Graham’s margin of safety: If you insist on a good price before you buy, a whole lot can go wrong and you’ll still end up fine.
I prefer two corollaries of my own. First, you can find margin of safety in terms of the businesses you select. Being a fair price for Exxon will put you in a better position than paying a fair price for a generic upstream oil company. The other corollary is collecting high dividends. Each dividend serves as a rebate on your initial purchase price, and if you get something that habitually yields above 5% or more, you will stockpile a lot of cash in just a few years. In these cases, looking at the stock chart alone can be misleading.
People write about BP as if it has been one great extended disaster for investors. But the numbers don’t back up that assertion. Yes, the dividend has been suspended and has not yet recovered from its pre-spill high. And yes, the price of the stock fluctuates all over the place. But the truth is this: If you had atrocious timing and bought at $43 during the year of the oil spill, and then witnessed a rough five years thereafter, you would be at the breakeven point. You’ve been protected on the downside by owning a productive asset that keeps pumping out profit.
Eventually, when oil prices recover, all these dividends paid out at low valuations will look quite impressive if you have chosen to reinvest along the way.
I suspect IBM will be the next candidate for “investment that looks like a disaster but the paper losses are much better.” If you pay $135 per share, you get a nearly 4% dividend yield. The dividend payout ratio is only 30%, and share buybacks alone will fund a decent dividend growth rate. It wouldn’t surprise me if the IBM investors of today manage to collect $30 in income per share for every piece of IBM that they purchase today. It’s the nature of enterprises that keep churning out cash. When dividends get paid, and ideally reinvested into another productive asset, a countervailing force is created to mitigate the bad news. The 2010-2015 period is one of the three worst stretches for BP in the past century, and an investor that does nothing managed to avoid any loss of note during this period. Sticking around and collecting cash for a few years can remove a lot of stock price risk from the market.