Oil stocks have been giving investors fits over the past year. The 50% haircut in the price of crude oil has taken many oil stocks down as much, if not more. That stomach-churning volatility is too much for some investors to handle. However, for those with an iron stomach there's quite a bit of money to be made in oil stocks -- if you have a long-term time horizon. Quite honestly, the secret to making money on oil stocks isn't trading, but buying to hold great oil companies for the next decade. It's a secret formula that's known as time arbitrage -- or patience for those who don't like fancy words.
Time is on your side
Time arbitrage, according to fellow Fool Jeremy Phillips, is "the concept of buying a stock from those with a different time horizon, and selling it on our own terms." Said another way by another smart Fool, Morgan Housel:
[Time arbitrage is] exploiting the gap between your time horizon and mine. If you're worried about the next six months, but I can be patient for the next six years, I have an edge over you. You may sell shares today because you don't want to have another down month, and I'll be happy to buy them from you to focus on my up decade.
Most investors today have a very, very short time horizon. Wall Street looks at the next quarter. High-frequency traders look at the next millisecond. But, long-term investors have the option of looking out decades -- and that's when the big money is made, not just in oil stocks, but stocks in general.
A trip down memory lane
To prove the point, take a look at the following historical chart for EOG Resources' (NYSE:EOG) stock.
Over the past few decades its stock is up about 3,700% even with the recent sell-off due to the plunging price of crude. Over that same time the market is up just 473% while oil has more than doubled. We can see that while EOG Resources' stock has a lot of correlation to the price of oil as it falls when oil falls, however, it has vastly outperformed the commodity. So, investors that bought the stock and held on through the oil busts have done quite well.
I included both the stock return and the total return which includes dividends. Clearly, investors that bought and held these stocks have done very, very well over the decades. But it wasn't always a smooth ride. I'm sure their investors fretted during the oil bust of the 1980s, which now looks like a minor blip on those stock charts. The duo has also survived every other crude oil price crash, and then thrived once normalcy returned to the market. It hasn't been a volatile ride for investors, but it has still been a quite profitable one for those that bought in one decade and held through the next.
The reason for this is oil companies firmly believe in the benefits of time arbitrage. We see it all the time. Oil companies invest money to drill an oil well today that will be producing decades from now. They know that the oil price today might be very different from the oil price next year or next decade. But, these companies are willing to invest in new wells in order to profit from the future production of those wells. It's a process that has worked for years and isn't likely to stop working any time soon. Again, the road might be bumpy, but over time it should be quite profitable.
It takes a long-term mindset to invest in oil stocks. An investor has to have one as the industry has a history of booms, busts, and subsequent recoveries. Just like an oil company investing in a new well, the key to success in oil stocks is to invest with a focus that is years if not decades into the future.