Oil stocks have been abysmal investments in recent years. Most have lost value, significantly underperforming the market.

However, one of the few bright spots has been Diamondback Energy (NASDAQ:FANG). The Permian Basin-focused oil company has produced a more than 260% total return since its initial public offering in late 2012. That has outpaced the S&P 500's more than 210% total return during that timeframe and the roughly 65% negative total return of oil stocks in the SPDR S&P Oil & Gas Exploration & Production ETF. What makes its outperformance even more impressive is that Diamondback has done it during a period when crude prices in the U.S. have lost roughly half their value. 

However, as the adage goes, past success isn't a guarantee of future performance. Given that, here's a look at the bull and bear case of whether Diamondback Energy can continue outperforming from here.

Oil storage tanks near a pumpjack and the sun in the background.

Image source: Getty Images.

The bull case for buying Diamondback Energy

Diamondback Energy has built up a massive resource position in the low-cost Permian Basin via a steady diet of acquisitions. The company is gobbling up more acreage this year, buying QEP Resources (NYSE:QEP) and privately held Guidon Energy's assets for more than $3 billion. Those deals will enhance its position as the second-largest producer in the Midland Basin side of the Permian, further increasing its scale and reducing costs. Thus, they'll improve its ability to operate at lower oil prices. 

Because of its low-cost resource base, the company can cash in at higher oil prices, which we've seen so far in 2021. Crude oil was recently in the low-$50s, which is well above its breakeven level in the low $40s. That's the price level needed to generate enough cash to maintain its production rate and dividend. That also means it's on track to generate a significant gusher of free cash flow this year.

The company doesn't currently have too much need for additional funding since it already has a strong investment-grade balance sheet and plans to keep its production flat with last year's level, given the oil market's current state. As a result, it should be able to return more cash to shareholders this year via a higher dividend and share repurchases. That could give the company's stock more fuel to continue outperforming.

The bear case against Diamondback Energy

While Diamondback Energy has outperformed the stock market, that's due in part to a big rally since November as shares are up more than 120% thanks to rebounding crude prices. Even with that rally, the stock is nearly 55% below its all-time high, showing how volatile it can be because of fluctuating oil prices. So if oil prices sell off, Diamondback Energy's stock will undoubtedly follow. If crude were to fall well below $40 a barrel again and stay there for a while, the company might not be able to maintain its production rate and dividend.

Meanwhile, a longer-term concern with Diamondback Energy is the global economy's steady shift toward renewable energy. That will reduce demand for fossil fuels in the coming years, which could keep the pressure on oil prices. Further, it will impact Diamondback Energy's ability to grow its production. If the company can't continue expanding its production and cash flow, its stock will likely underperform over the long-term.

The odds of continued outperformance seem diminished

If oil prices continue rebounding, Diamondback Energy's stock will probably keep heading higher. Because it should generate a gusher of excess cash that it will probably send back to investors, this could be a solid option for investors who are bullish on oil prices.

However, given its exposure to oil price volatility and the long-term headwinds facing that market, it doesn't look like a compelling long-term investment opportunity for those not quite so bullish on oil prices. Many companies are in a better position for the future of energy, which increases the probability they'll outperform Diamondback and the S&P 500.  

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.