Last year, BP (LSE: BP) shares paid a total dividend of 28 cents, fixed at a sterling equivalent of 22.5p. On the current £3.96 share price, this generates a yield of 5.7%.
The rate compares extremely favourably to the current average FTSE 100 return of just 3.6% and to the FTSE 250’s 3.3%.
That said, analysts forecast the yield will go even higher to the end of 2026. Already this year, the oil and gas giant raised its first and second interim dividends by 10%.
If the remaining two dividends this year are raised the same amount then the total payout would be 30.8 cents. On the current exchange rate, this would equate to 23.6p, which would produce a yield on the present share price of 6%.
Looking further ahead, analysts predict payments equivalent to 25.5p in 2025 and 26.8p in 2026. These would generate respective annual yields of 6.2% and 6.6% on the present share price.
How much passive income could be made?
Passive income is money made with little effort. The best way I have yet found to generate it is by investing in stocks that deliver high yields.
So, £9,000 (the amount I began investing over 30 years ago) of BP shares would currently produce £513 in dividends.
Therefore, over 10 years on the same average 5.7% return, £5,130 would be made. And after 30 years on the same basis, £15,390.
However, the returns could be much higher if the dividends were used to buy more BP shares – called ‘dividend compounding’.
Turbocharging returns by reinvesting dividends
By doing this on the same 5.7% average yield, £6,893 in dividends would be made after 10 years, not £5,130. And after 30 years of the same, the BP investment would have generated £40,560 of dividends rather than £15,390.
Including the initial £9,000, the total value of the holding would be £49,560. And by that point it would be paying £2,825 a year in passive income, or £235 each month!
Are the shares undervalued as well?
That said, I would not want my dividend gains to be wiped out by share price losses should I want to sell the stock.
To reduce the chance of this happening, I always look for undervalued shares, and I think BP’s fit the bill.
It looks very cheap on the key price-to-earnings (P/E) stock valuation measurement at just 10.7. This is bottom of its competitor group, which has an average P/E of 14.4.
To translate this into hard cash terms I ran a discounted cash flow analysis. This shows BP shares to be 23% undervalued at the present price of £3.96. So, a fair value would be around £5.14.
They may go lower or higher than that, given market unpredictability. However, it underlines to me how much of a bargain they look right now.
Will I buy the shares?
Ultimately, a company’s share price and dividend are driven by earnings growth. A risk here for BP is a long-running decline in energy prices.
However, analysts forecast that its earnings will increase by 9.2% a year to the end of 2026.
This – together with its good yield and notable undervaluation – means that I will be adding to my existing stake in the firm very soon.
This post was originally published on Motley Fool
