The Income Investor: does BP have dividend investing appeal?

The BP logo at the ICE Krakow Congress Center in Poland last month. Photo: Klaudia Radecka/NurPhoto via Getty Images.

Many income investors disregard companies that have a relatively volatile financial outlook. After all, a bottom line that has the potential to fluctuate significantly due, for example, to a rapidly changing economic outlook can equate to a less reliable dividend.

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As a result, investors who depend on their portfolio for a steady flow of dividends may focus only on stocks in defensive sectors such as utilities or tobacco, thereby avoiding relatively cyclical mining or energy firms that are less likely to offer a consistent or reliable income stream.

Reward potential

However, companies that have a relatively cyclical financial performance can offer higher dividend yields than their defensive counterparts. Investors typically demand a wider margin of safety to take into account the greater chance of a dividend cut or other associated financial challenges, which may lead to a more attractive prospective income return.

Such companies may also be better placed to generate faster dividend growth over the long run, since they are likely to be more positively impacted by an upbeat global economic outlook than their defensive peers. This point is arguably of greater importance now than in the past, given that investors still have to contend with a period of sticky inflation, which is making it more difficult to obtain real-terms growth in their income.

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Furthermore, the prospects for dividend growth among relatively cyclical firms could prove to be buoyant amid the ongoing period of monetary policy easing that is taking place across much of the developed world. Once time lags have passed, interest rate cuts enacted over recent months and, potentially, over the coming months could act as a catalyst on the world economy and, therefore, the operating environments, profitability and dividend outlook of cyclical firms.

A wider margin of safety that takes into account the potential for highly changeable earnings forecasts and resulting uncertain dividend prospects may also mean greater scope for an upward rerating. This could equate to substantial capital growth over a multi-year time frame.

Source: Refinitiv as at 3 December 2025. Bond yields are distribution yields of selected Royal London active bond funds (as at 31 October 2025), except global infrastructure bond which is 12-month trailing yield for iShares Global Infras ETF USD Dist as at 2 December. SONIA reflects the average of interest rates that banks pay to borrow sterling overnight from each other (2 December). Best accounts by moneyfactscompare.co.uk refer to Annual Equivalent Rate (AER) as at 3 December. *Includes introductory bonus.

Greater risk

While cyclical stocks can offer greater rewards than their more defensive peers, they are inherently riskier. Income investors should therefore proceed with caution when focusing on them, with a well-diversified portfolio that contains a range of companies from different sectors and geographies being a requirement.

In addition, income seekers should only focus on high-quality firms that are well placed to overcome underlying economic ebbs and flows which are highly likely to impact on their financial performance. For example, companies that have generous dividend cover, which means they can easily afford to pay their current dividends with their most recent level of profits, are less likely to need to cut shareholder payouts during periods of economic uncertainty.

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Similarly, companies that have a solid balance sheet due to it containing only a modest amount of debt are likely to find it easier to service their borrowings across a range of operating conditions. Solid finances may also mean they are in a strong position to invest in growth opportunities, thereby providing greater scope for long-term profit and dividend increases.

Income investors should demand a margin of safety that fully compensates them for a higher level of risk among cyclical firms. A modestly higher dividend yield or an earnings multiple that is only slightly lower than those available among stable, defensive firms may, for example, fail to represent a worthwhile risk/reward opportunity. Investors should, therefore, only focus on cyclical stocks whose shares trade significantly below intrinsic value.

Dividend appeal

Despite its 27% share price rise over the past six months, oil major BP (LSE:BP.) still has an annualised yield of 5.4%. This is 220 basis points higher than the FTSE 100 index’s yield.

Furthermore, the energy company’s dividends per share have increased by 5.9% year on year in the first nine months of the current financial year. This is 230 basis points ahead of the current annual inflation rate and means the firm’s shareholders have experienced a real-terms increase in their income over recent months.

The company is also aiming to raise dividends per share by at least 4% per year in future. Given that the Bank of England expects inflation to moderate to its 2% target by the first half of 2027, this is likely to equate to further positive dividend growth for BP’s investors in real terms.

A cyclical business

Of course, the company is highly dependent on the global economy’s growth rate. Its financial performance has therefore proved to be relatively volatile over recent years, with its latest quarterly results providing evidence of this. For example, its earnings per share (EPS) declined by 19% year on year during the first three quarters of the current year due in part to lower commodity prices.

Although interest rate cuts across developed economies are likely to have a positive impact on the firm’s long-term financial performance, it would be wholly unsurprising for the company’s bottom line to continue to experience sizeable fluctuations in future.

Solid fundamentals

However, BP’s dividend payments were amply covered over 1.5 times by profits in the first nine months of the year. This suggests that even a sharp deterioration in its financial performance may not require a commensurate decline in shareholder payouts.

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The company also has a solid financial position through which to overcome temporary economic uncertainties. Although its net debt has increased by over 7% in the past year, its net debt-to-equity ratio still stands at a relatively modest 34%. Finance costs in the first nine months of the year, meanwhile, were covered 3.4 times by operating profits.

The firm’s financial prospects are being strengthened via cost cuts. In the first half of the current year, for instance, the company delivered structural cost reductions of $0.9 billion (£674 million). This takes the total recorded since the start of its ongoing efficiency programme to around $1.7 billion.

Capital growth prospects

As well as having an uncertain operating outlook due to the prospect of further economic undulations, BP is in the midst of conducting a review of its portfolio. The company is set to divest in excess of $4 billion of assets in the current financial year, with major changes to its operations having the potential to cause additional volatility in its financial and share price performance as it seeks to focus on its most profitable assets.

Over the long run, though, a focus on higher-returning assets could have a positive impact not only on the firm’s financial performance but also on investor sentiment. BP’s shares, even after their rise in recent months, still trade on a price/earnings (PE) ratio of just 11.1. This suggests there is scope for a substantial upward rerating, and thereby capital growth, given that the FTSE 100 index currently trades on an earnings multiple of 17.6.

Risk/reward opportunity

Undoubtedly, BP’s financial performance, share price and dividend are likely to be less stable or consistent than many other FTSE 100 index stocks. Indeed, it is possible to find a wide range of such companies elsewhere in the UK’s large-cap index.

However, BP’s attractive yield, ample dividend cover and sound financial position suggest that it is a high-quality income stock. When coupled with its dividend growth potential and scope for capital growth amid an improving global economic outlook, it appears to offer a favourable risk/reward opportunity as part of a diverse income portfolio.

Robert Stephens is a freelance contributor and not a direct employee of interactive investor.