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Investing in Energy Stocks

Updated: Dec. 17, 2021, 4:52 p.m.

The energy sector is vital to the global economy by producing and supplying the fuels and electricity it needs to keep humming along. The energy industry includes companies involved in the following activities:

  • Renewable energy stocks: These companies produce electricity using renewable resources such as solar, wind, hydroelectric, and geothermal.
  • Solar energy stocks: This subgroup of renewable energy focuses on manufacturing solar panels and components to generate electricity from the sun. It can also include companies focused on owning and operating solar energy generating facilities.
  • Oil stocks: Oil companies focus on exploring for, producing, transporting, or refining crude oil.
  • Natural gas stocks: Natural gas companies concentrate on exploring for, producing, transporting, or exporting natural gas.
  • Liquefied natural gas stocks: A subgroup of the natural gas industry, liquified natural gas (LNG) companies develop and operate facilities to liquefy natural gas for export.
  • Electric utility stocks: Electric utility companies generate and distribute electricity to customers.

This broad industry is crucial to providing the economy with the energy it needs. It's also an important one for investors to understand.

Energy sector stocks to buy

Hundreds of public companies focus on the production and distribution of energy. However, a few leaders stand out because of their size and financial strength. Here are three of the best energy stocks to consider buying:

Company Ticker What it does
ConocoPhillips NYSE:COP Globally diversified oil and natural gas producer
NextEra Energy NYSE:NEE Leading utility and renewable energy producer
TC Energy NYSE:TRP Leading pipeline operator and electricity producer

Source: Companies' websites

Here’s a closer look at some of the best energy stocks in the industry.

ConocoPhillips

ConocoPhillips (NYSE:COP) is a diversified oil and natural gas producer. It has operations around the world and uses several methods to produce oil and natural gas.

ConocoPhillips stands out for its low operating costs. It has an average cost of supply of less than $30 a barrel. The company made two acquisitions in 2021 -- Concho Resources and Shell’s (NYSE:RDS-A) Permian Basin assets -- to increase its scale and help to further reduce costs.

ConocoPhillips complements its low cost of supply with a strong balance sheet. It has an investment-grade bond rating backed by a low leverage ratio. That provides it with plenty of cushion to weather periods of low oil and gas prices, which happen quite frequently in the industry.

ConocoPhillips’ low operating costs position it to generate significant cash flow in the coming years. The oil and natural gas company estimates it can produce a cumulative $80 billion in free cash flow by 2031. That assumes oil prices average $50 per barrel. The company anticipates returning nearly all of that money to investors in the coming years via dividends and share repurchases.

NextEra Energy

NextEra Energy (NYSE:NEE) is one of the country's largest electric utility companies. It's also the global leader in producing power from the wind and sun through its energy resources segment. That business sells clean energy to other utilities and end users around the country.

Both businesses generate relatively stable cash flow. It sells and distributes power backed by government-regulated rates and fixed-price contracts with customers. This business model is very resilient because businesses and households need a steady supply of power.

The company has one of the best financial profiles in the electric utility sector, and it has one of the highest credit ratings in its peer group. NextEra also has a conservative dividend payout ratio for a utility, which adds to its strong financial profile. Those factors enable NextEra to pay a stable and growing dividend, making it an excellent renewable energy dividend stock.

TC Energy

TC Energy (NYSE:TRP) is one of the largest natural gas pipeline operators in North America. It has natural gas pipelines in the U.S., Mexico, and its home country of Canada. In addition, the company owns a premier liquids pipeline system, making it one of Canada's leading oil exporters. It’s also one of the country’s largest power producers with a focus on nuclear energy and renewables.

These energy infrastructure assets generate relatively stable cash flows. The company leases its capacity under fee-based contracts and regulated rates. This low-risk business model has proven to be highly durable as TC Energy generates steady cash flow in all market environments.

Meanwhile, the company has a conservative dividend payout ratio. It also has one of the top credit ratings in the pipeline sector. Those factors give it the financial flexibility to continue expanding its pipeline network and its dividend. They also make TC Energy one of the lower-risk companies in the energy sector.

How to invest in the energy sector

The energy sector is a challenging one for investors, especially oil and natural gas companies. Energy prices can change in a heartbeat. This volatility can have a massive impact on the sector, as well as on the global economy.

We’ve seen this firsthand in recent years. Oil and natural gas prices plunged during the early days of the pandemic as demand dried up. However, they rebounded sharply in 2021 as consumption recovered.

Because of the impact commodity price volatility can have on the energy sector, investors need to understand how to invest in energy stocks. That includes keeping downside risk in mind. This factor should emphasize not allocating too much of a portfolio to one energy stock or the industry as a whole. Further, investors should focus on oil and natural gas companies with the financial and operational strength to survive if industry conditions significantly deteriorate.

Factors that increase an energy company's durability include:

  • A low-risk business model: For oil and natural gas producers, this means having diversified operations and low production costs. Meanwhile, energy infrastructure companies should have stable revenue with minimal exposure to fluctuations in volumes or pricing, e.g., operations supported by regulated rates or long-term fixed-fee contracts.
  • A strong financial profile: Balance sheet factors to consider are a high investment-grade credit rating, lots of liquidity (cash on hand and borrowing capacity), and minimal near-term debt maturities. In addition, it should have a conservative dividend payout ratio compared to its peers.
  • Manageable capital spending programs financed primarily with post-dividend free cash flow and prudent use of debt.

Energy companies with these characteristics will be in a better position to withstand the inevitable cyclical downturns. That means they'll still be around when market conditions improve. Furthermore, they'll have more flexibility than their weaker peers to capture opportunities that can create value for their investors.

Energy stocks are important but risky

The energy sector is vital to the global economy because it provides the fuel and power needed to drive trade and travel. However, when the economy slows, as it did during the COVID-19 pandemic, it can have a major impact on energy demand and prices. That can put significant weight on energy stock prices. Conversely, when the economy hits the accelerator, which happened in 2021, demand soars and usually takes prices up with it.

Because of that, the best energy stocks to buy are those that can easily survive a downturn. That factor also puts them in the best position to thrive when market conditions improve. Another factor energy stock investors should consider is focusing more attention on cleaner energy companies using renewable sources. That’s especially important during the Biden administration, given its pledge to put the country on a path toward an emissions-free future.

FAQs

What are the best energy stocks to buy?

A few leaders stand out because they’re larger in size and have strong financial profiles. Here are three of the top energy companies to consider:

ConocoPhillips: Globally diversified oil and gas producer

NextEra Energy: Leading utility and renewable energy producer

TC Energy: Leading pipeline operator and electricity producer

Are energy stocks risky?

The energy sector is vital to the global economy because it provides the fuel and power needed to drive trade and travel. However, when the economy slows, as it did during the COVID-19 pandemic, it can have a major impact on energy demand and prices. That can put significant weight on energy stock prices. Conversely, when the economy hits the accelerator, which started happening in 2021 as more vaccines rolled out to limit the pandemic, demand soars and usually takes prices up with it. Because of that, investors should focus on the stocks of companies that can easily survive a downturn. In addition, they should consider focusing more attention on cleaner energy companies using renewable sources.

What are the best utility stocks?

The best utility investments are companies with a top-notch financial profile and visible growth prospects. Each of the companies below meets those criteria and has the potential to produce above-average total stock returns -- dividend yield plus stock price appreciation.

Here is a list of standout companies, followed by our assessment of each investment:

American Water Works is the largest publicly traded water and wastewater utility in the U.S.

Brookfield Infrastructure Partners owns a diversified portfolio of infrastructure businesses.

NextEra Energy operates regulated electric utilities in Florida. It also owns a nonregulated competitive energy business that operates natural gas pipelines and renewable energy projects.

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