![\"\"](\"http:\/\/www.credittrends.com\/blog\/wp-content\/uploads\/2010\/07\/BP-NPV-07-15-2010.jpg\" "\\"BP")
Surprise!\u00a0 Investors get giddy, and we are seeing it with BP.<\/p>\n
In fact, BP\u2019s 7.5% rise today questions investor logic, absent a takeover bid, (less than 3% chance), or the price of crude jumping over $ 90\/bbl.<\/p>\n
This is because under the most optimistic of logical scenarios, one in which is as follows:<\/p>\n
(1)\u00a0 BP generates in excess of $3 billion in free cash flow this year and over $6 billion next (events which are extremely unlikely), and<\/p>\n
(2) \u00a0its free cash flows exceed its past three-year average (pre-Gulf tragedy) starting in 2014,<\/p>\n
(3)\u00a0 its free cash flows rise by 45% over its past three-year average by 2016, and<\/p>\n
(4)\u00a0 we attach no more risk to this cash flow scenario than exists for the median S&P Industrial firm, meaning the increase in risk \u00a0associated with the past 2 months\u00a0disappears.<\/p>\n
These four assumptions, if realized, result in a current fair value of $43.25. A more realistic fair price is $40.37, which also takes off the table any additional negative event impacting the best-case cash flow forecast.<\/p>\n
However, given another nasty surprise, the cost of equity capital (risk) is almost certain to jump over 11% . \u00a0I say an investment in BP is not worth\u00a0 the risk for a minor return, especially as far greater opportunities, with considerably less risk exists elsewhere, both inside the sector and outside of it.<\/p>\n
A 10% fall in the price of energy, even given a market cost of capital, takes the stock down at least 15%.\u00a0 Of course, there is always the possibility that rumor and innuendo could take the stock higher, but I\u2019m not one to invest in the greater fool theory, although that seems to work more often than I care to think.\u00a0 Remember residential real estate?<\/p>\n