Benefits and risks of investing in energy stocks
Some of the positives of investing in energy stocks include:
- Growth: Energy demand is growing, especially for lower-carbon energy such as natural gas and renewables.
- Income: Many energy stocks pay high-yielding and steadily rising dividends.
- Inflation protection: Energy producers earn more money when oil and gas prices rise. Meanwhile, many pipeline companies and utilities benefit from inflation-linked contracts or regulated-rate structures.
On the other hand, the sector has some potential negatives, including:
- Price volatility: Oil and gas prices move with supply and demand, making the industry very cyclical. Energy prices can be highly volatile, significantly affecting energy company earnings and stock prices.
- Geopolitical and policy risk: War, OPEC policy decisions, sanctions, and changes in government energy policy can affect demand and prices.
- Long-term demand headwinds: Climate change and the shift towards cleaner energy sources could reduce fossil fuel demand over time.
Methodology: How these stocks were chosen
The energy sector is capital-intensive, volatile, and shifting towards cleaner sources. I looked for companies that paired strong financial profiles with clear long-term growth catalysts. I evaluated each pick based on:
- Balance sheet strength: I favored investment-grade credit ratings.
- Durable cash flow: I preferred those with long-term contracts, regulated rates, or integrated operations that can withstand energy price volatility.
- Growth visibility: I looked for companies with a defined backlog or management guidance through the end of the decade.
- Shareholder returns: I sought companies that paid a growing dividend, repurchased shares, or both.
Brookfield Renewable, Chevron, NextEra Energy, and Enbridge ranked high across those categories. Bloom Energy is the lone exception. It stood out for its robust growth in what's typically a slow-growing sector, though it is the highest risk energy stock on this list.
Should you invest in energy stocks?
The energy sector can suit those seeking dividend income, inflation protection, or exposure to rising demand. However, it's riskier than other sectors due to its combination of cyclicality, volatility, and geopolitical impacts.
There are ways to lessen those risks. Pipeline companies, utilities, and renewable power producers tend to generate more durable cash flows. Meanwhile, integrated producers are more resilient than small exploration and production companies. The industry also offers meaningful growth potential for companies in emerging sectors, such as fuel cells. Investors need to choose the energy stocks that align with their goals and risk tolerance.
Alternatively, if you want exposure to the sector without trying to pick winning energy stocks, you can consider an energy ETF. Either way, most investors will probably want to limit their energy sector exposure to a small piece of a diversified portfolio.
