BP Oil Fiasco

June 2010, Business2Business

The oil giant's plunging fortunes show why investors should not put all their eggs in one basket.

Since the end of March, investors’ attention has been focused on Europe’s debt crisis and whether this will stop the global economic recovery in its tracks. During the last few weeks, however, another story has dominated the financial headlines: the oil spill in the Gulf of Mexico and the fallout from this for BP. For investors with large holdings in BP, it has been a stark reminder of the perils of placing all your eggs in one basket.

Since the start of the spill six weeks ago, BP’s share price has tumbled losing almost half its value. Its market capitalisation is now less than that of its rival, Royal Dutch Shell, and there has been talk of a potential takeover bid. Further, investors reliant on the upcoming dividend payment from BP to support their lifestyle needs may find themselves struggling if the company decides to retain the dividend. This demonstrates that established companies – often referred to as “blue chips” – are not bulletproof and can fall quickly from grace, often spectacularly so.

Blue chips are the cream of the crop: shares that are issued by large, well-established firms with a long and stable record of earnings and dividends. New Zealand investors have also seen some of their renowned companies stumble in recent years. Household names like PGG Wrightson, Fisher & Paykel Appliances and Telecom all experienced big share price drops during the last decade.

PGG Wrightson has been severely hit by the downturn in the rural sector. From its peak of $2.94 in August 2009, PGG Wrightson is now trading at $0.55. Moreover, the company did not pay a dividend in its June 30, 2009 year and said it will not pay a dividend in the 2010 year. In June this year, after a troubling few months that saw major disruptions to its XT network and a cut in its earnings forecast, Telecom’s share price reached an all-time low of $1.81. That’s a staggering 81% drop since its peak of $9.70 in early 1999. Fisher & Paykel Appliances, once heralded as a New Zealand success story, has seen its share price fall by 83% since July, 2004, due to struggling sales and high debt levels.

The above examples highlight why people should not build their investments around a single company or industry. It doesn’t matter whether blue chip companies dominate their markets or that they have high-profile backers - sometimes unforeseen events occur that undermine them.

The only protection for investors is having a properly diversified portfolio. This will include large company shares and small company shares, domestic and international shares and emerging market shares. The exact mix will be determined by the investor’s financial goals and risk tolerance. Of course an investor’s portfolio may include BP or Telecom or PGG Wrightson. The important point is their portfolio is not built around a view about the oil exploration industry, telecommunications industry or rural sector.

Diversification reduces the impact of random forces on your portfolio - such as an oil spill in the Gulf of Mexico.