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Here's Why Wall Street's Experts Hate Robinhood's Most-Popular Oil Stock

By Matthew DiLallo – Updated Jun 26, 2020 at 11:10AM

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Analysts and amateurs have very different definitions of what makes a bargain stock, and that disparity is on full display when it comes to Marathon Oil.

Marathon Oil (MRO 3.90%) is among the 100 most widely held companies among retail investors using popular stock-trading app Robinhood. More than 200,000 of them have picked up shares of the low-priced stock, making it the most-owned oil producer on the commission-free trading platform.

However, while Robinhood traders are buying Marathon, a growing number of Wall Street analysts are advising investors to sell it. Here's a look at why they hate this oil stock.

Bull and bear statues.

Image source: Getty Images.

Sell, sell, sell

Analysts at financial giant Wells Fargo have a mixed view on Marathon. On the one hand, the bank has a $10 price target on the stock, which implies that it sees significant upside potential from the current sub-$6 share price. However, that didn't stop the bank from downgrading Marathon this week from overweight to equal weight, a lukewarm rating at best. While the oil company has a track record of producing a fair amount of free cash, the bank's analysts believe it will need to spend more than 70% of its cash flow from operations on maintaining its current production rate. That leaves little wiggle room for growth spending or free cash generation. Further, Wells Fargo analysts believe that investors are valuing the stock as if oil will average $50 a barrel, whereas they value others in the sector at a $40 a barrel price estimate. Because of that, the bank has concerns about Marathon's valuation. 

Meanwhile, powerful investment bank Goldman Sachs also downgraded Marathon's stock this week, cutting its rating from neutral to sell, while leaving its price target unchanged at $6 per share. Driving the downgrade was the bank's view that the company's production could fall off a cliff through the end of this year because it's not drilling enough new wells to replace legacy wells as they deplete. That could cut into its future cash flow and its ability to benefit from higher crude prices if oil recovers. 

These recent downgrades follow one last month from investment bank Morgan Stanley. At the time, it downgraded Marathon's stock from equal weight to underweight -- equivalent to a sell rating -- and set its price target at $5 per share, a bit below where it's currently trading. Driving that dour outlook is the bank's view that it's "unwarranted" for Marathon to trade at a valuation in line with its peers, given its "more challenged outlook." In order for it to produce oil at a profit, Marathon will need prices to be above $37 a barrel next year -- a higher breakeven level than its competitors. And its projected leverage level at the current oil price is 4.5 times, more than double the peer average of 2.0 times.

Price is what you pay; value is what you get

The big disconnect between Wall Street analysts and Main Street traders comes from the fact that the former focus on underlying value while the latter put a big emphasis on the price. Thus, many retail investors see a stock that's trading in the single digits and has lost a lot of value lately, and think it's a bargain. By contrast, Wall Street considers how much investors are paying for a company's cash flow.

That's one reason why Morgan Stanley has a much more bullish view on oil stock Parsley Energy (PE), which it upgraded to overweight (or buy) when it downgraded Marathon. While Parsley's current stock price is more than double Marathon's at over $10 a share, Morgan Stanley notes that it trades at a peer-leading free-cash-flow yield, meaning it's the cheapest stock in its class based on that valuation multiple.

Meanwhile, analysts at bank SunTrust love higher-priced oil stocks like Diamondback Energy (FANG 2.12%) and Pioneer Natural Resources (PXD 2.20%), which currently trade at more than $42 and $95, respectively. Fueling the bank's bullish view is its belief that investors are materially underestimating those companies' ability to generate free cash flow next year. Thus, while they might not trade at low stock prices, they sell for low multiples of their projected cash flow, making them cheap stocks on a valuation basis.  

A low share price doesn't mean a bargain stock

Many of the most popular stocks on Robinhood have relatively low per-share prices, and Marathon fits that description. One factor driving retail traders toward such stocks is that it intuitively appears easier for a $5 stock to double in value than one trading at $50 a share. However, that's not how things actually work in the equities market.

Ultimately, the market values stocks based on a host of metrics that weigh (among other things) the underlying businesses' earnings and cash flow. The share price as a number, whether high (like Pioneer) or low (like Marathon) is not particularly important. Because of that, over the longer term, a high-priced stock trading at a relatively low cash-flow multiple compared to its peer group has a better chance of outperforming a low-priced stock that's trading at a premium valuation.  

Matthew DiLallo has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Marathon Oil Corporation Stock Quote
Marathon Oil Corporation
$28.25 (3.90%) $1.06
Pioneer Natural Resources Stock Quote
Pioneer Natural Resources
$256.70 (2.20%) $5.52
Diamondback Energy, Inc. Stock Quote
Diamondback Energy, Inc.
$142.33 (2.12%) $2.96
Parsley Energy Stock Quote
Parsley Energy

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