I've neglected this blog for a while due to other commitments but came back to talk for a moment about market sentiment, behavioural psychology and value investing in the context of BP shares (BP.LON) in the wake of the oil spill.
Now this is not meant to be a crowing session (okay it is) but it struck me during all the panic about BP that the market had over-reacted completely to the extent of the spill. BP is a firm that throws off cash and unless you are expecting a huge double dip recession you have to believe that Chinese oil demand is going to keep driving up the price of oil - not forever mind you as substitutes such as tar sands in Canada become increasingly competitive about $70-$80 a barrel so there is some supply response as well as demand elasticity.
Either way you have to believe that under most scenarios BP will generate about $10 billion in profit each year (after the costs of finding new oil to replace each barrel it sells). This is obviously very geared to oil prices so could be significantly higher.
Now that may look scary in relation to the companies potential liabilites related to the spill, which may hit up to $30 billion - but I find it hard to believe its total liability will get that high. The big bulk of is expected to come from government fines of up to $21 billion. But that depends on whether gross negligence can be proved and my reading of the situation (as a non-lawyer) is that this could be difficult and could take many years. I would expect that a settlement is reached for a far smaller sum to satisfy the government rather than have 10 years of hearings and appeals. BP at this stage has every incentive to hire the best lawyers and get the best scientists to contest the government's estimates and claims. Even if over the longer run the claims were to reach that level were are not talking of 2-3 year's profit swallowed up in one gulp, but more likely an amount that gets paid over many years in nominal terms (ie today's dollars).
The long and short of this is that when the market was selling the shares right down to £3 a share, the lowest in 16 years, I took a small punt in my personal account and moved a few thousand (all I have to play with) out of corporate bonds and into BP, getting the stock at £3.05. I was lucky. A lot of people tried to catch this falling knife on the way down. I guess the fact that I called the bottom exactly was really due to the fact that I came to the party late and only ran the numbers when it seemed everyone else had given up on the stock, which as of this time is now back up to above £4. The final tally on the liabilities could still go higher than I think and this bet could have gone quite wrong. It may yet if BP finds it is unable to drill in American waters again. But it is a useful reminder of the old philosophy that the time to buy is when blood (or in this case oil) is flowing in the streets.