I covered BP stock publicly for the first in March 2013 when the price of the gigantic oil corporation was $40.33. The article was titled “The Role of BP’s Dividend In Preserving Your Wealth Over The Medium Term.”
My thesis statement was this: “One of my favorite things to do when researching investments is to conduct studies on realistic worst-case scenarios for blue-chip stocks. Almost every time, the result I have found has been this: if the dividend remains reasonably intact and the underlying business maintains solvency, the total returns for seemingly dreadful stocks is never quite as bad as you might think by looking at a stock chart alone.”
That argument was part of my ongoing efforts to debunk some of the fear-mongering that drives a lot of investment commentary that uses the common crutch of pointing to a stock at a recent high and then citing a recent low as a reason to fear the bogeyman markets. That kind of “analysis” tends to ignore the impact of dividends altogether and completely neglect the possibility of initiating positions at a reasonable price.
The price of oil at the time I wrote the article was $102.52 per barrel. If you were looking for short-term profits, the timing of my article was not good. The price of oil remained above the $100 range for the next year, marched down to $60 per barrel at the end of 2014, fell to the $40 range in early 2015, hit the $29 range in early 2016, and has since advanced to $37 per barrel. I basically pointed out the value of BP a year before the price of its key product began a steady march to a 60% decline.
But there were two things I got right: The first is that the price of BP was more than reasonable at $40.33 per share, well below the $53 per share rights it would reach the subsequent summer. If oil stayed in the $75-$125 range from that point, investors stood make somewhere between “very good” and “excellent returns.”
If the price of oil fell, the single digit P/E ratio compared to earnings over a projected business cycle provided a fair amount of protection against potential hard times in the oil sector. With a declared dividend of over $2 per share in relation to a $40 share price that was fully supported by ongoing cash flows, I concluded that the combination of fair price and cash generation would either enhance returns if oil performed well or significantly limit the downside if the price of oil took a hit.
The latter scenario is what played out in real life.
I get a lot of good-natured ribbing from other investment writers due to my affection for the rarely loved British stocks like GlaxoSmithKline and BP (though I tend to have much more consensus support on Royal Dutch Shell and Diageo), and I get where it’s coming from. The returns from these enterprises haven’t been great in the recent past or even fifteen year past.
But here is why, despite little peer support regarding stocks like BP, I still like it.
Forgetting the oil spill, the past three years have been some of the worst for oil sector businesses. In terms of rig count declines, this has been the hardest decline since the 1800s. As an operational matter, it joins the late 1990s and circa 1986 period as the worst business conditions for oil stocks in the past 35 years.
And yet, consider what would have happened to someone who bought BP stock during the time I first covered it in March 2013, and just left the account to nature the past three years.
You would have collected $2.19 in 2013 dividends, $2.34 in 2014 dividends, $2.40 in 2015 dividends, and $0.60 through the first quarter of 2016. That’s $7.53 per share in cash. The price of the stock has declined from $40.33 to $32.15. If you didn’t reinvest, the net value of your dividends plus BP shares would have the economic value of $39.68. The third worst business conditions in the past two generations, and you’d only be down 1.61%. A $10,000 investment in BP in March 2013 would currently have a net worth of $9,839. This underlying reality is far superior to the headline news items that trumpet the 60% decline in the price of oil and the doom and gloom that surrounds the operators in the sector.
If you reinvested, you would have collected $8.14 that got reinvested at an average price of $37.22. In just over three years, you got to turn each share of BP into 1.21 shares of BP. A 100 share position purchased at $40.33 would have seen the economic value of the stake turn into 121 shares of BP worth $3,890 (from an initial point of $4,033). Your decline would have been 3.54%.
A $10,000 initial BP investment would be worth $9,649 today had you reinvested during the past three years. This is one of those rare instances in which reinvesting reports worse results than letting dividends pile up as cash because the price of reinvestment in the early years and the extra cash resulting from that is less than the magnitude of the price decline since 2013.
I bring up this parable because I want everyone reading this to understand how the bad news that you see in the investment commentary section doesn’t actually translate into the net worth harm that you might intuitively think it does. Once you factor in the dividends of cash-generating assets, and once you get a reasonable price from the offset and let the money compound for a little bit, you will see much better results than what the headlines suggest.
Oil has fallen over 60% in the past three years. It has not been a good time to operate in the sector, or be an employee in it. Those things are all true. But the shareholders in those corporations have only sustained losses of slightly above 1% or 3%, depending on how you treated the dividends. The harm has been negligible.
I also find it likely that a day will come when the shareholders of BP will come to appreciate these days because it had a turbo-charged effect on their wealth creation. Jeremy Siegel first introduced me to this concept when I read “Stocks For The Long Run” and saw how Philip Morris’s 6% dividend, reinvested upon itself over and over again for decades at low prices, created more wealth than any other American stock. The spring-back effect that happened to Johnson & Johnson dividend re-investors in the 2010s after seeing dividends stagnate will one day be the case for shareholders of both BP and GlaxoSmithKline. Those 5%, 6%, 7% dividends reinvested in the upper $30s and low $40s will be viewed much more favorably when business conditions improve and those stocks trade in the $60s.
No one wants to see money stagnate. That’s obviously not the objective of any investment from the onset. But if you learned that you could invest in a stock on the eve of one of the worst cyclical downturns in the past two generations and only be down a percentage point or two, wouldn’t you raise a glass to Benjamin Graham’s margin of safety principle?