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Billionaire Warren Buffett is one of the best-known and widely followed investors in the world.
And for good reason. He has handily beaten the market for nearly half a century. However, even the very best can get it wrong.
Last year, Buffett’s Berkshire Hathaway (NYSE:BRK-B) bought up 40 million shares of ExxonMobil (NYSE:XOM). This put the oil company as Buffett’s seventh-largest holding and made Buffett’s conglomerate one of Exxon’s top-five shareholders.
This isn’t a huge surprise since we know that Buffett loves “flight to safety”stocks. And will Buffett lose money on this bet? Not likely.
However, I’d argue that investors can do much better in today’s market. Over the last five years, ExxonMobil has underperformed the S&P 500 by 50% on a total return basis (including dividends and stock appreciation).
Given its large asset base, growing earnings has become quite a task for ExxonMobil. It’s also hard to cut costs enough to grow the bottom line. But many investors are drawn to ExxonMobil given its dividend-growth history.
It seems to be the perfect stock for investors in search of the 9th wonder of investing — using dividend stocks to build wealth. It has increased its annual dividend for 31 straight years. Its dividend yield is 2.8%; the average dividend yield for the S&P 500 is 1.9%.
But for investors truly looking to build wealth with income, there’s one stock that offers 75% more income than ExxonMobil. That stock is BP (NYSE: BP).
BP’s current dividend yield towers over ExxonMobil’s, coming in at 4.9%. It has paid a dividend every year since 1985. BP also only trades at a forward P/E (price-to-earnings ratio using next year’s earnings estimates) of 9.7, compared to ExxonMobil’s 12.6.
The stock is likely still trading at a discount to its peers given the pending resolution of the Deepwater Horizon litigation. But in the 20 years before the 2010 Deepwater Horizon incident, BP outperformed the S&P 500 by over 150% on a total return basis. There’s plenty of potential for BP to do this over the next 20 years.
While there’s no way to know how long the litigation will persist – it took ExxonMobil over 20 years to fully settle all the Exxon Valdez claims – it is encouraging that BP has managed to strengthen its balance sheet over the last few years. Ultimately, making any additional litigation charges easier to withstand.
Its cash position has increased 50% over the last three years and its net debt (debt less cash) has declined by nearly 30% for the same time period. BP is also planning to sell off some $10 billion in assets through 2015. This includes turning its focus to offshore drilling. BP remains the largest leaseholder in the Gulf of Mexico for deepwater drilling leases.
And over the past few years, the company has been utilizing a profit and margin expansion strategy, rather than focusing on increasing volume. As part of this, BP is downsizing its portfolio, ultimately hoping to only focus on its most profitable assets. As a result, Wall Street expects BP to grow earnings at a rate that’s 66% higher than ExxonMobil over the next five years.
Even still, shares of BP are down close to 10% over the last month. This comes despite posting strong second-quarter earnings results.
Driving the stock down was news that further Russian sanctions by the U.S. or European could hurt its business. Of all the major Western companies, BP probably has the most to lose in Russia, with a 20% stake in the world’s largest publicly traded gas and oil company, Russia’s state-owned Rosneft.
BP has noted that “Russia is the largest oil and gas producing country on the planet, and the world is going to need 40% more energy between now and 2035.”It’s easy to see why the company sees a presence in Russia as a must.
But BP’s investment in Rosneft actually helped boost second-quarter results. During the second quarter, BP’s replacement profit (net profit less inventory gains or losses) was up 34% year-over-year to $3.64 billion.
With the recent pullback, BP now trades at a discount to its five-year average P/S (price-to-sales) and P/B (price-to-book) ratios. The market appears be offering long-term investors yet another great entry point into one of the world’s largest oil and gas producers.
ExxonMobil’s relatively low dividend yield just means investors are not only stuck with an underperforming stock, but they are also missing out on quarterly income. BP offers a $2.31 per share annual dividend payment, which is a dividend yield that’s 75% higher than ExxonMobil.
Sorry, Mr. Buffett. This is one time you got it wrong.
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