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The 1 Stock You've Been Overlooking for Your Roth IRA

By Reuben Gregg Brewer - Nov 17, 2018 at 11:47AM

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An out-of-favor energy giant that has proven itself through thick and thin is on sale today and sports a high yield.

One of the biggest benefits of a Roth IRA is that the money you put in is after tax, which allows you to pull money out tax-free. That makes a Roth a great place to own dividend-paying stocks like ExxonMobil Corporation (XOM 1.98%). However, the headlines today are filled with news of oil falling into a bear market, and, worse, Exxon has been trailing its peers on some key metrics. But long-term investors should have Exxon on their short list.

The bad news

Let's start off with the bad news. Oil prices have recently collapsed more than 20% in a very short period of time. They remain well off the lows following the deep downturn that started in mid-2014, but it's impossible to deny that the action in the oil market is troubling right now. Still, that's just par for the course. Oil is a commodity prone to dramatic and often swift price swings. Exxon is used to this and prepared (more on this in a second).   

The words IRA and Roth IRA on a piece of paper with a red pencil to the side. Roth IRA is circled in red.

Image source: Getty Images.

That's a problem affecting the entire energy sector. Exxon is also dealing with some company-specific issues. Notably, oil production has been falling for a few years. It dropped 1% between 2015 and 2016, with a further decline of 1.5% between 2016 and 2017. In the third quarter, a decline of 2% year over year added to the bad news. On top of that, Exxon's return on capital employed, a measure of how well a company is using investors' money, has fallen from industry-leading levels to just middle of the pack. Exxon is struggling a little bit today. However, it's working on the issues.   

And then there's the big-picture issue of a world that's shifting toward cleaner fuels. That includes everything from renewable power to natural gas, which is seen as a transition fuel. Environmental activists would have you believe that oil is dead.

It's not.

The good news

After all of that bad news, it's understandable that investors aren't thinking about putting an oil company, let alone Exxon, into their Roth IRAs. But that's a potential mistake. For starters, the fact that oil is a volatile commodity is well known. Exxon has specifically designed its business to deal with the ups and downs. That includes being diversified across the upstream (oil drilling) and downstream (refining and chemicals) businesses. When oil prices fall, the downstream side of the business tends to benefit because the cost of its prime input falls. To put a number on that, in 2015, earnings in Exxon's upstream operations fell a massive 75%, but earnings in the downstream business more than doubled. The end result was an overall decline of just 50% -- not great, but the downstream clearly softened the blow of what was a very deep oil downturn.   

XOM Debt to Equity Ratio (Quarterly) Chart

XOM Debt to Equity Ratio (Quarterly) data by YCharts.

Underlying that diversification is Exxon's conservative balance sheet. At the end of the third quarter, long-term debt made up just 9.5% of the company's capital structure. That's a low level for any company in any industry. Exxon has more than enough room on its balance sheet to survive an oil downturn while continuing to invest in its business and pay shareholders a steadily rising dividend. That idea is backed by the incredible 36 consecutive years of dividend increases the oil giant has amassed -- something that no other peer has achieved. Note that Exxon increased its dividend during the last downturn even while peers were cutting or pausing their dividend hikes.   

With regard to production, Exxon is not only aware of the issue but it has plans to fix it. Only it refuses to increase production for the sake of increasing production; it's focusing on adding high-value production, with big projects in deep water oil, natural gas, and onshore U.S. oil drilling. Getting those going is going to take some time. But even though Exxon's long-term goals reach out to 2025, there are signs of progress, notably in the U.S.     

Onshore U.S. production increased 17% between the second and third quarters. That helped push overall production up 5% sequentially, even though production was down on a year-over-year basis. In other words, the company appears to be turning a corner on the production front. And as more of its big projects start to come on line, the story will only get better. That, in turn, will help its return on invested capital, because it is taking a leading role in more of its projects so it can put its expertise in running giant investments to work. The goal is to push return on capital employed up into the mid-teens by 2025.   

XOM Dividend Yield (TTM) Chart

XOM Dividend Yield (TTM) data by YCharts.

As for oil's long-term outlook, the picture isn't nearly as bleak as some would have you believe. Yes, clean energy is taking a larger share of the energy market. But oil is projected to be a key piece of the puzzle for decades. In fact, demand from emerging markets is likely to keep oil demand growing, slowly, for at least another two decades. And since oil and natural gas are depleting assets, more drilling will be needed to replace the fuel that gets used. There's really no reason to worry about Exxon going the way of the dinosaurs just yet.   

Put this one on the list

With all of that as a backdrop, you might also be interested to know that Exxon's dividend yield is higher than it has been in roughly 30 years. It's price to tangible book value, meanwhile, is lower than it's been over about the same time span. In other words, it looks mighty cheap today. And, as noted above, the reasons for the low valuation aren't as worrisome as Mr. Market seems to think. If you are looking to add a high-yield stock to your Roth IRA so you can generate tax-free income in retirement, Exxon should be on your short list today.

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