Although we don't believe in timing the market or panicking over market movements, we do like to keep an eye on big changes -- just in case they're material to our investing thesis.
Once again, Seadrill (NYSE:SDRL) stock is getting crushed, falling as much as 8% in today's trading. And, once again, the major drop doesn't correspond with a fall in earnings or any other company-specific news. Instead, it's a move driven by macro events and fear that they'll hurt earnings in the future. Here's how I think you should look at Seadrill now.
What's driving Seadrill lower
Like it or not, what's driving Seadrill in the short term is the price of oil. You can see below that the recent sell-off has corresponded closely with the fall in oil prices.
For traders, the logic isn't completely flawed, it's just very short-sighted. If oil prices remain where they are today, or even fall further, it's likely that demand for offshore drilling rigs will wane, and dayrates and profits will suffer in the future.
But let's be clear that Seadrill's earnings haven't been bad so far in 2014, and there's still plenty to like in the company now and in the future.
So what should you do about it?
The reason I think the stock's drop recently is overdone is because it's overlooking the fact that Seadrill has one of the newest fleets in the industry and has long-term contracts for most of that fleet. The floaters Seadrill owns have 96% contract coverage for the remainder of this year, 80% next year, and 62% in 2016. In short, short-term oil price movements have little to do with the company's long-term earnings.
With that said, if oil prices remain low for the next few years then there's a lot to be worried about. But I don't think oil will stay low for long because big oil has already started to cut back on capital spending, and smaller shale producers need to have high prices to remain profitable.
The short-term picture looks bleak if you're looking just at oil prices but long-term Seadrill is in a strong strategic position if oil prices recover.
What to do now
The big question is whether you should be a buyer or seller of Seadrill stock today. It may be tough to stomach, but I think this is a time to buy because oil prices will rise long-term, and Seadrill is well positioned for long-term growth in the offshore market.
Even founder John Fredriksen gave investors an indication that he's in for the long haul by recently buying 2 million more shares of the stock.
Days like today can be tough to watch, but it's key to take a long-term approach to stocks like Seadrill. It has a lot going for it as long as oil prices recover in the next year or two. In the meantime, there's high contract coverage for the company's rigs, which will keep revenue coming, and management has flexibility in financing new rigs with its Seadrill Partners subsidiary.
The upside is just too high for Seadrill to be a sell now. There could be further downside, but I think the risk/reward is in investors' favor after the recent drop. But be prepared for volatility, because energy markets are moving dramatically everyday right now and often for no reason. That's unnerving, but it's also when long-term investors can make a fortune.
Travis Hoium manages an account that owns shares of Seadrill. The Motley Fool recommends Seadrill. The Motley Fool owns shares of Seadrill. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.