What do Warren Buffett, Carl Icahn, and Sam Zell have in common? Other than the fact that they are all billionaire financiers, they do share one other trait -- they are all bargain-hunting in the energy sector. And there are plenty of bargains to be had. After a tough decade in which the oil and gas sector's weighting in the S&P 500 index has dropped from 13% to 4%, the sector is now trading on less than half the market's price to book multiple. Is the smart money onto something?

There are also reasons other than valuation which may be attracting attention to the sector. With the recent listing of Saudi Aramco, the Saudis seem to be very keen in supporting the price of oil, which is the single largest driver of profitability in the sector. U.S. shale companies have also become a little more disciplined in managing their production, as funding has dried up. Finally, after a brief spate of weakness, the global economy seems to be on the mend. All of which would suggest that, for the intrepid investor anyway, the sector merits a second look.

Oil rig and tanker

Image source: Getty Images. 

With over 600 companies in the sector, there's a lot to choose from. Given the historical boom to bust (and back again) tendencies of the sector, a long term investor would best be served by buying a company with a solid balance sheet, diversified business model, and a track record of paying dividends so as to capture returns even if the business goes south. Chevron (NYSE:CVX) fits the bill perfectly.

A safe pair of hands

As one of the largest integrated oil companies in the world, Chevron has exploration, production, and refining operations worldwide. The company produces 2.9 million billions of oil equivalent (BOE) a day, making it the second largest oil producer in the US. Production rose 7% in 2018 and is on pace to rise 6% in 2019, the highest growth rate among its peer group.

This growth is primarily attributable to the investments Chevron made in various liquid natural gas (LNG) projects, notably Gorgon and Wheatstone in Australia, where production is now being ramped up -- with 400,000 BOE added in 2019. The next stage of growth will be driven by its differentiated Permian position, where it owns 2.2 million acres with a low royalty rate. Not only is Chevron leading in production growth, but it's also doing this at higher margins. Morningstar estimates mid-cycle margins at $30/BOE, the highest among its peers.

One factor which has distinguished Chevron has been its disciplined approach to capital allocation. Chevron has consistently focused on projects anchored predominantly on short cycle low risk and high return investments and has accordingly shifted much of its exploration efforts out of frontier settings over the past several years. Chevron has also been reluctant to rush into acquisitions where the returns are questionable -- its walking away from the Anadarko deal is a case in point.

As a result of these efforts, Chevron has managed to reduce its annual capital and exploratory expenditures by $20 billion over the past five years. Spending will likely remain muted around current levels over the next five years as well, in contrast to Exxon, which plans to boost spending significantly. This, combined with aggressive cost-cutting efforts, is a major reason why Chevron has among the best free cash flow profiles in the sector. The company is one of the few oil majors to generate enough free cash flow to cover dividends and share repurchases. This should enable a steady stream of dividend increases, extending a streak which has continued for 32 consecutive years.

Buying dividend growth at a cheap price

Chevron's dividends are nothing to laugh about. At over 4%, the company's dividend yield is 60% higher than one would get with an equivalently rated corporate bond. Valuation expansion can also be expected, as Chevron's stock currently trades at a price to cash flow multiple of only 7.2, compared to its five-year average of 9.7. With the stock trading at a discount to its historical range and sporting a hefty dividend yield, Chevron seems a safe bet to play an oversold sector.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.