Tuesday, 1 June 2010

Valuing BP and more pain for buy and hold investors

BP's market capitalization has dropped by almost one third in the last few weeks. Clearly some major institutions have been selling and probably a lot more are on the verge of doing so. Many of those selling are institutional investors such as pension funds which are run by managers who claim to be proficient in properly "valuing" businesses, and indeed are paid well for that proficiency.

While other companies have suffered large drops in a similar length time frame the situation with BP is rather different. This is not a sexy, flavor of the month company that has suddenly passed its sell by date but a rather boring oil company (until recently).

What is one of the more disturbing aspects of BP's plight, dwarfed, of course, by the ecological disaster, is that the collapse in the company's share price calls into question the entire methodology of corporate valuation and the critical role that risk assessment plays in that process.

The BP calamity can also act as an antidote for typical investor who has had BP in his/her portfolio for several years as a blue chip that need not be scrutinized frequently. The prospect of a Chapter 11 filing for the company, if the worst estimates of the costs and damages to the company turn out to be true, would be yet another example of wealth evaporation inflicting serious pain on those subscribing to a passive buy and hold investing philosophy.

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