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The Ultimate Contrarian Bet: BP at Trader’s Narrative

Right now, BP is a true test for contrarian investors. It is hard to find a stock so reviled, a company so hated and a future more bleak than BP. But have we reached the point of maximum pessimism?

For a clue, let me go back to an anecdotal sentiment gauge that I shared with you back in the darkest days of the bear market. On Monday, October 20th 2008, the satirical news show, “The Colbert Report” talked about the CBOE volatility index and even showed a graph of it. At that time, I said, “Now watch volatility implode.”

Four trading days later on (Friday) October 24th 2008, the VIX spiked up to an intra-day high of 89.53 and the next trading day on October 27th 2008 it closed at the high of 80.06. While the volatility index did return to those heights again in late November 2008 - creating a double top, by the end of the year in 2008 it was below 40 and by the end of 2009 below 20. So all things considered, this anecdotal sentiment indicator was not too shabby.

When a comedy show that is watched by the general public refers to an esoteric stock market measure like the VIX, it isn’t hard to imagine that we’ve reached an inflection point. The same can be said right now for BP. If you were watching on Thursday, both Stephen Colbert and Jon Stewart referred to the dramatic decline in BP’s stock price.

Jon Stewart (on the Daily Show) showed a recent chart of BP which was clearly marked, with a red downward arrow, showing a decline of -51.7%:

Daily show BP stock chart Jun 2010

You can watch the clip here:

Canadian readers can watch the clip here.

Colbert also made fun of the decline in BP’s stock, saying, “The only thing lower than BP’s blown well is their stock price. And then facetiously recommends it, “Investors, stick with BP and I guarantee you, we’ll all be in the black.” Adding later, “That’s my stock pick. Put everything in BP.” But he didn’t show a stock chart.

Canadian readers can watch the clip here.

They both poked fun at the recent press release from BP in which the company says, “The company is not aware of any reason which justifies this share price movement.”

Colbert BP press release Jun 2010

At first, that might seem to be a surreal thing to say and both shows, as you’d expect, have a field day with it. But if you read the sentence before that it says, “BP notes the fall in its share price in US trading last night.’ - referring to trading on June 9th 2010.

The distinction that is lost among the public is that a company and its stock are two very different things. Simply buying a stock because you like their “story” or you use their products without any understanding of valuation is financial suicide. It worked for Peter Lynch, the famed Fidelity manager and he wrote “One Up on Wall Street: How To Use What You Already Know To Make Money In The Market”. That book made millions of amateur investors believe that they could just buy a shoe company’s stock because their kids liked their shoes.

The important thing to remember is that Lynch came on the scene at the start of a powerful secular bull market. He started running Magellan for Fidelity in 1977, right at the end of a grueling bear market that had pummeled stocks to astonishing valuations. In such an environment, it wasn’t too difficult to be an outstanding investor.

So if we distinguish between skill and market environment we quickly realize that the price you pay for something is important. And so is the gap between value and worth. This is where the naive investor makes his or her first mistake.

Click to see larger version in a new tab:
BP long term chart Jun 2010.png

Right now BP is trading at such depressed levels that it is selling less than the sum of its parts. As well, if you look at the long term chart, you’ll see that there is significant long term support under the $30 level. As a reader pointed out in the comments, the chart was wrong, so I’ve corrected it. In fact, BP has broken long term support and is now far above the next long term support level of $20/share.

Interestingly enough, both of the shows were on Thursday night, the day after BP’s shares had fallen dramatically in the stock market. But that was the low (for now) and BP has recovered from $29 to $33.97.

Scott Adams, the creator of Dilbert gets the distinction I made above. Sort of. Check out his WSJ article where he explains why he bought BP stock recently.

dilbert buys BP shares

Since Adams is a nerdy clown, I’m not sure how seriously we should take him. But it really isn’t about buying companies that you love, nor is it about buying companies that you hate. It is all about what price you pay and what you get in return.

For more meaty fare, and less comedy, check out Barry Ritholtz’s 10 thoughts for those considering buying BP shares.

And finally, here’s the damage done to BP’s brand according to BrandIndex. The folks at Goldman Sachs might want to take a hard look in the mirror since they are actually trailing lower than BP!

BandIndex BP compared to Toyota GS Jun 2010
Hat tip to Felix

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15 Responses to “The Ultimate Contrarian Bet: BP”  

  1. 1 Frank Ochoa

    Very nice read!

    I tend to see $35 as the price between long term bulls and bears. The stock had been able to remain above the $35 level for some time, but recently crashed to $29 before closing the week just shy of $34.

    The influx of buyers below $35 indicates that responsive market participants are seeing price as undervalued at this point (at least in the short term). The volume climax as price rebounded from $29 also indicates potential strength ahead. But $35 remains the key…

    I’ll be watching this level very closely..


    Frank Ochoa

  2. 2 PEJ

    Hi Babak,
    I just thinking the same thing about a few days ago, before the massive 15% rally. My conclusion is that it could be a great win, but it could also be a great fall. Finger pointing and scape goating are the name of the game during depressions. Politics looking for boosting their % approval will take any chance they get. Just look at Obama, he would happy to take his chances against them, right?

    It’s a great contrarian play, but it’s also a big gamble/bet and there’s a lot of uncertainty, maybe too much.

  3. 3 Ken

    That long term chart of BP is wrong. My charts and trading software show the low for the month of January 2003 to be 34.67. It matters since that would mean BP broke support and it is now resistance. That chart is off on many other calcs too EXCEPT the last few months, surprising. The market is just full of cheaters…

  4. 4 Babak

    Thanks Ken, I’ve corrected the chart.

  5. 5 Ken

    Thanks for correcting that chart. BP may be undervalued, but with all the unknowns regarding costs and fines to make the situation whole, who really knows. The price is below all the MA’s and technically many supports are broken, looks like it will be a slow recovery for BP IMO.

  6. 6 Babak

    I don’t disagree with your analysis but my point was that it looks like everyone is thinking the same way. And you know what usually happens when everyone agrees on something in the market.

  7. 7 PEJ

    yes indeed… One way to play this might be with options. I haven’t checked the implied vols though.

  8. 8 Babak

    Another thing to keep in mind is that a typical hedge fund play in this situation is to buy the beaten down bonds and sell short the equity to get a neutral exposure.

  9. 9 PEJ

    Looks like Bill Gross did a fine job buying short term BP bonds at rock bottom prices.
    And so far we did a good job too, not buying the equity yet…

  10. 10 PEJ

    FYI guys; I’m testing the water and bought a small amount of shares yesterday just before the close. Let’s see what will happen now :-)

  11. 11 PEJ

    Still following up on my own comments.
    BP seems to have bottomed on the 24th or 25th of June.
    Today it’s up nicely in premarket at around 32.52…
    Where to put the stop and the exit points are the tough questions now…

  12. 12 PEJ

    Amazing… BP is almost trading at $39 in the after market, up 12% for the day, on take over rumors…

  13. 13 Babak

    Jeebuz! $38.89… shoulda bought more… lol

  14. 14 PEJ

    Yeah me too… Coulda/Shouda/Woulda!

  15. 15 PEJ

    Babak, BP is close to $40 — hope you didn’t sell and actually bought more.
    I did neither…

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