Even a quick glance at BP (LSE: BP) shares suggests they are undervalued compared to their potential. Energy prices worldwide have rallied over the past year, buoyed by the global economic reopening and falling supply.
Thanks to rising energy prices, the company’s profits have jumped. City analysts expect the group to report a net profit of $12.5n this year, followed by nearly $13.3bn in 2022.
To put these figures into perspective, the corporation’s profits have not exceeded $10bn in a single year since 2014, when the oil price collapsed as output surged in the US shale oil boom.
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Based on this potential, City analysts believe BP shares are trading at a forward price-to-earnings (P/E) multiple of 6.8 for 2022. This appears incredibly cheap compared to the market average multiple of 14.
At the same time, the company could also offer investors a dividend yield of 4.6% in the year ahead.
Avoiding BP shares
However, while the stock does look cheap, I think it is worth analysing why investors might be avoiding the shares. First off, there are a couple of reasons that could explain the low valuation.
For a start, energy prices tend to be highly volatile. Oil and gas prices have jumped over the past couple of months, but there is no guarantee this trend will continue. The global shift away from hydrocarbon energy towards renewable and green energies will almost certainly impact demand for oil and gas in the long run. If BP does not change with the times, it could be left behind.
This is another reason why the market may be avoiding the company. Asset managers around the world have been laying out plans to divest oil and gas holdings from their portfolios in response to the climate change debate. This shift has had a marked effect on the value of hydrocarbon producers worldwide.
BP shares are no exception.
Looking to the future
Despite these concerns, I think the stock looks incredibly attractive. Not only does the investment appear to be undervalued compared to its growth over the next few years, but the company is also investing heavily for the future.
The group is looking to invest in and build renewable energy capacity of 20 gigawatts by 2025 and 50 gigawatts by 2030. Rising oil and gas prices will only help the organisation meet this goal.
With profits surging, the company has plenty of capital to invest in its growth initiatives. Previously, the group has relied on debt to fund growth. With profits and cash generation rising, BP can use its income from legacy oil and gas operations to grow the business for a greener future.
This transition is the main reason why I would buy the stock for my portfolio today. BP shares look cheap compared to its potential, but there is far more to the company than its profit growth over the next couple of years. Rising profitability today should guarantee its long-term success and, as a long term investor, that is something I am incredibly excited about.
