Great investors make money in a variety of ways, but one thing they typically share is the ability to identify opportunities when they arise and take maximum advantage of them. The energy sector has gone through extreme volatility in recent years, as huge moves in the prices of crude oil and natural gas have caused wild swings in many stocks throughout the industry. Smart investors have paid close attention to oil stocks in the hopes of finding strong future performers among the industry's top names, and three things in particular are making oil stocks favorites among top investors right now.
1. Oil stocks are cheap
Many oil stocks have posted huge losses in recent years as their profits have fallen due to weaker energy prices, and that has left them trading at attractively inexpensive levels. Exacerbating the decline, many energy companies had made substantial investments when crude oil traded above $100 per barrel, and the level of leverage that smaller exploration and production companies took on left them extremely vulnerable to the industry's downturn. The result has been massive asset sales throughout the energy sector, often at bargain prices compared to what they sold for just a few years earlier.
Long-time energy investors understand that the oil and gas industry is cyclical, and boom and bust periods are a regular feature of the investing environment in energy. By buying oil stocks at the bottom of the cycle when times look horrible, smart investors put themselves in a position to reap the rewards when the industry inevitably recovers and high-quality energy companies start to see better performance again.
2. Oil stocks pay dividends
Dividend-paying stocks have become a necessity for income investors to get the portfolio income they need, because traditional income-producing investments like bonds have had extremely low interest rates for years. That has led to a huge increase in valuations among most dividend-paying stocks, and even low-growth defensive consumer names now sport earnings multiples that would have been reserved for small high-growth companies with much better prospects for expansion.
In an environment in which nearly all dividend-paying stocks have gotten too expensive, the exception has been in the energy sector. Many high-yield oil and gas investments are structured as master limited partnerships, distributing most of their earnings as dividends and making them extremely valuable for income investors. Nervousness about the sector has kept valuations down -- even for companies that aren't as exposed to the ups and downs of oil and natural gas prices. It's true that some energy stocks have had to resort to dividend cuts in order to preserve capital during tough times. Yet the highest-quality companies have found ways to keep making those dividend payments. By being willing to take on some risk, income investors who buy energy stocks could see a much better potential reward than those who are paying inflated prices for stocks in other sectors without the same prospects.
3. Oil stocks have growth potential on top of simply reaping rewards from higher energy prices
Finally, energy stocks stand to win not just if oil and gas prices rise. Many companies have growth initiatives in the works that could dramatically expand their businesses. On the exploration and production side, regular advances in drilling methods have brought life to areas that were once believed to be entirely depleted and helped discover opportunities for development. The discovery of these areas -- often in regions that don't have extensive energy infrastructure -- has led to a boom in demand for new pipelines and other energy transportation assets. Meanwhile, even the largest players in the industry are looking closely at acquisition opportunities to ensure they can retain their size and influence over the energy sector. All those factors add up to chances for the energy sector to grow.
Watch what smart investors are doing
Smart investors look for opportunities wherever they arise, and the energy sector is a great place to search. Between bargain prices and growth potential, focusing on the oil patch is a smart move to make right now.