Conventional wisdom says that you buy cyclical companies when they have high P/E ratios, which indicate that earnings have bottomed and the cycle is set to turn.
As you can see in the table below, oil and gas stocks are not trading for historically high P/E ratios. In fact, most are trading for historically low P/E ratios -- or at least, multiples well below their 5-year averages.
|
Company |
Current P/E |
5-year average P/E |
|---|---|---|
|
ExxonMobil |
9.6 |
12.1 |
|
ConocoPhillips |
7.3 |
8.6 |
|
Schlumberger |
21.6 |
35.6 |
|
Apache |
8.8 |
10.5 |
|
Nabors Industries |
11.3 |
19.3 |
Data from Capital IQ and Morningstar.
Yet I think now is shaping up to be a very good time to buy them, and I'll tell you why.
Mo' money, mo' problems
"Big oil," you may have noticed, has been in the news a lot lately. When Exxon booked record $11.7 billion second-quarter earnings on July 31, it was excoriated by politicians and pundits alike for its "outrageous" windfall profits. Not long thereafter, presidential candidate Barack Obama proposed a $1,000 energy rebate program for families, funded by "profit penalties" imposed by the government on oil companies that sell oil for anything more than $80 per barrel.
(At the time of publication, I had no word from Sen. Obama's campaign on whether similar profit penalties would be imposed on Apple
With oil prices remaining well north of $80 per barrel, and Sen. Obama leading his opponent, John McCain, in seven of eight major national polls, this "profit penalty" proposal (say that 16 times fast) and other regulatory threats have given energy companies and their investors reasons to be wary.
That's right, wary
A profit penalty would not just increase taxes, but reduce the viability of exploration and production in expensive places such as the Canadian oil sands and the very deep water. This would slash capital spending on equipment and services throughout the industry, thus reducing the earnings and growth potential of the entire energy sector.
Put that threat alongside the recent drop in oil prices, from around $145 to $116 (which means the product is selling for less), and oil and gas investors are on alert. That explains recent volatility in the industry's stocks, as well as some extremely negative reactions to a few less-than-stellar earnings reports.
As a long-term, value-focused investor, however, that increased pessimism among short-term investors creates an increased opportunity for me to buy some well-positioned oil and gas companies on the cheap.
Here's why
See, despite strong words to the contrary, I'm skeptical of the fact that we'll ever see a "profit penalty," regardless of who is elected in November. Such a policy would have a very difficult time gaining approval in both Congress and the forum of public opinion. Moreover, given increasing emerging-market demand and slowing production at mature fields, I also believe that high energy prices (in the range of $90 to $100, at least) are here to stay. It's the law of supply and demand.
Thus, I'm more than happy to buy quality oil and gas names when their prices are depressed by short-term fears. The long-term money-making opportunity in the space far outweighs the short-term threats.
Can you dig these three stocks?
At Motley Fool Hidden Gems, we focus on finding small, well-run companies with wide market opportunities that are trading at value prices. This strategy (which has helped our picks beat the market by 22 percentage points on average) often has us searching through out-of-favor industries for the very best operators.
Right now, despite our bullish long-term outlook on the economy, one of those industries is energy. Here are three quality operators in the space that recently popped up on my radar:
- W&T Offshore
- Colfax
-
Global Industries
(NASDAQ:GLBL)
Though these three stocks each have significant and important exposure to the energy industry -- W&T as a driller, Colfax as a pump maker, and Global Industries as an offshore construction -- jittery energy investors overreacted to their recent less-than-stellar earnings reports or outlooks. So they're cheap today, even as their long-term opportunities remain immense.
If you share our outlook for the energy space, and you're looking to add energy exposure to your own portfolio, these are three quality names. You can also see the rest of our Hidden Gems research and recommendations by joining our service free for 30 days.
Click here for more information.
Tim Hanson owns shares of W&T Offshore and Colfax. Apple is a Motley Fool Stock Advisor recommendation. Though the Fool's disclosure policy acknowledges that money can't literally buy you happiness, it would note that money can buy you a boat named "Happiness."
