Is BP an Investment or Speculation?

| About: BP p.l.c. (BP)

From Google Finance:

BP p.l.c. (NYSE:BP) is an international oil and gas company. The Company operates in more than 80 countries, providing its customers with fuel for transportation, energy for heat and light, retail services and petrochemicals products. The Company operates two segments: Exploration and Production, and Refining and Marketing. Exploration and Production’s activities cover three key areas. Upstream activities include oil and natural gas exploration, field development and production. Midstream activities include pipeline, transportation and processing activities related to its upstream activities. Marketing and trading activities include the marketing and trading of natural gas, including liquefied natural gas (LNG), together with power and natural gas liquids (NGLs). Refining and Marketing’s activities include the supply and trading, refining, manufacturing, marketing and transportation of crude oil, petroleum and petrochemicals products and related services.

Does BP make for an intelligent investment or intelligent speculation today? Starting with a base estimate of annual Free Cash Flow at a value of approximately $10,000,000,000 and the number of shares outstanding at 3,130,000,000 shares; we used an assumed FCF annual growth of 6 percent for the first 10 years and assume zero growth from years 11 to 15. Review the Free Cash Flow record here.

The resulting estimated intrinsic value per share (discounted back to the present) is approximately $46.76.

Market Price = $42.95
Intrinsic Value = $46.76 (estimated)
Debt/Equity ratio = .31
Price To Value (P/V) ratio = .92 and the estimated bargain = 8. percent.

Before we make a purchase, we must decide ( filter #1 ) if BP is a high quality business with good economics. Does BP have ( filter #2 ) enduring competitive advantages, and does BP have ( filter #3 ) honest and able management.

The current price/earnings ratio = 6.8
Its current return on capital = 12.19
Using a debt to equity ratio of .31, BP shows a 5-year average return on equity = 23.4

Some industries have higher ROE because they require no assets, such as consulting firms. Other industries require large infrastructure builds before they generate a penny of profit, such as oil refiners. Generally, capital-intensive businesses have higher barriers to entry, which limit competition. But, high-ROE firms with small asset bases have lower barriers to entry. Thus, such firms face more business risk because competitors can replicate their success without having to obtain much outside funding.

Growth benefits investors only when the business in point can invest at incremental returns that are enticing; only when each dollar used to finance the growth creates over a dollar of long-term market value. In the case of a low-return business requiring incremental funds, growth hurts the investor. The best companies sustain a competitive advantage, produce free cash flow, and use debt wisely.

Does BP make for an intelligent investment or speculation today? Time is said to be the friend of the wonderful company and the enemy of the mediocre one. Before making an investment decision, seek understanding about the company, its products, and its sustainable competitive advantages over competitors. Next, look for able and trustworthy managers who are focused more on value than just growth. Finally ask: Is there a bargain relative to its intrinsic value per share today?

Great investment opportunities come around when excellent companies are surrounded by unusual circumstances that cause the stock to be misappraised. In terms of Opportunity Cost, is BP the best place to invest our money today?

Time forward projection:

How will BP compete going forward? Keep in mind that a financial report like this is a reflection of the past and present. It may be used to project a future, but it may not account for factors yet unseen. Therefore, pay attention to competitive and market factors that may affect changes in profitability.

In summary, using a debt to equity ratio of .31, BP shows a 5-year average return on equity = 23.4 The estimated intrinsic value per share (discounted back to the present) is approximately $46.76. The Market Price = $42.95 and the Debt/Equity ratio = .31

The Price To Value (P/V) ratio = .92 and the estimated bargain = 8. percent.

Going forward, after this great oil spill of 2010, are there any tranformational catalysts or condition indicators imaginable on the horizon that can adversely affect long-term profitability?

Disclosure: No positions