Why Oil Stocks Belong In Your Stock Portfolio

oilstocks

Here is a crazy statistic that crossed my desk recently about the performance of the Big Oil supermajors in relation to the S&P 500 over the past twenty years: every single supermajor outperformed “the market” since July 8th, 1993.

Over that time frame, BP returnd 9.6% annually.

Total SA returned 10.9% annually.

Chevron returned 12.7% annually.

Exxon returned 11.8% annually.

Conoco returned 12.0% annually.

Meanwhile, the S&P 500 returned 8.6% annually.

The secret to the success of the big oil companies is that they are able to fire on all cylinders: they pay a healthy dividend, they buy back their own stock, and they put in the needed capital expenditures to fuel future growth. It is a great way to add meaningful diversification to your portfolio because when oil prices rise, most other S&P 500 stocks fall, and vice versa. That is to say, when oil prices are rising rapidly, your oil stocks will go up while your other holdings might experience a bit of a drag.

And the great part is that a big chunk of the total returns from these stocks come in the form of dividends. In the case of Exxon and Chevron, you get a low starting yield and a high dividend growth rate. In the case of Conoco, BP, and Total, you get a higher starting yield and a lower dividend growth rate.

Personally, I think each of these five stocks (plus Shell) serve as the great pillars of an income portfolio. Some people shy away from energy investments as long-term investments because they fear the non-renewable nature of fossil fuels or the ever present threat that “alternative energies can offer.”

In response to the first objection, it is all about the reserve replacement rate. If you are replacing your reserves at a rate over 100%, you are increasing your available resources to work with. If an oil company falls to reach that 100% threshold, then it is depleting resources and getting smaller. If an oil companies has a reserve replacement rate at less than 100% for a long period of time, that is a huge warning bell. Reviewing five years of history, the only oil supermajor that had a reserve replacement rate of less than 100% is BP, and that is because it had to sell off assets after its oil spill (read: it had to address a one-time event).

As for alternative energy, look at what happened when natural gas emerged. The Big Oil companies just gobbled up the trillions of cubic feet of natural gas, collectively. Exxon and Chevron have tens of billions of dollars in cash on hand. That doesn’t just disappear overnight. When solar energy, windmills, or whatever become viable competitors to “old energy”, which companies do you think will gobble them up? I’ll give you a hint. It ain’t gonna be Tim’s Lemonade Stand. It’s going to be the energy companies with billions of dollars of cash on hand, ready to pounce. There is a reason why they have been rebranded as “energy” companies instead of “oil” companies.

In my opinion, the sensible way for an income investor to approach energy investing is to buy each of the supermajors, and make each one 2-4% of your portfolio, with a target of having 15% or so of your net wealth in Big Energy. They provide great and reliable income streams. Feel free and take those dividends and deploy them elsewhere. It’s like having your own little oil way you can tap for cash every ninety days.

 

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8 thoughts on “Why Oil Stocks Belong In Your Stock Portfolio

  1. says:

    Agree completely. XOM, CVX and COP make up about 11% of our div portfolio. My goal is to make that about 20%, but only because we have large cash holdings in other portfolios. Otherwise, I would be shooting for the 15% you mention. CVX is our lightest holding, so it's my first focus.

    Not much use for Total or BP. Total gets taxed heavily by the Frenchies, and I pay zero taxes on the US companies (Roth account). BP is a bit too volatile/risky for my taste. Nice article, Tim.

  2. Actually, right now energy makes up 100% of my equities portfolio. That will change as I add other investments going forward. LINE has been one heck of a ride for the past week. YIKES! However, I trust management and think the issues will be resolved in a positive way. Meanwhile, the tremendous distributions are a nice repayment for my putting up with tremendous volatility.

  3. I really like big oil as well and I've been keeping my eye on them as I raise the capital for my next purchase. Like it or not the world will be using fossil fuels for a long long time to come and I think it's a safe place to put ones money.

    Cheers,

    CD

  4. Tampabay says:

    Tim, If this wasn't a "buy em all article" and you could only own one (1) big oil, which one would it be?, I know you have said you like BP, but would that be your "best" for the future?

    1. Tim McAleenan says:

      At the current price, probably Royal Dutch Shell. That 5%+ dividend is hard to screw up, and compounds quickly if you reinvest. However, I currently own BP because it has much better total return potential, IMHO.

      However, with Total SA, Conoco, BP, and Shell, you will encounter some dividend freezes and maybe cuts along the way, especially if you have a 20+ year holding period in mind. If that doesn't suit what you're trying to do with your portfolio, I'd look to Exxon and Chevron—if you buy Exxon, it's one of the few ways to get reliable dividend growth even when we return to the bottom of a commodity (i.e. oil and natural gas) cycle.

  5. Steve Melnykevich says:

    Tim,

    Excellent reply above. I completely agree. However, my current route is to load up on BP and CVX which ironically and independently we came to the same conclusion….15% of portfolio. I actually sold some AAPL shares (at a small loss) to do the prudent thing and diversify into the undervalued oil sector. That accomplished two goals for me. 1. to reduce my AAPL holdings from 70% to 50%. 2. Expand my investments into the oil sector. Once AAPL recovers within the next 1-2 years I will slowing reduce my holdings down from 50% to about 5-10% as I work towards a 10 year plan of reaching 5% per holdings. I recently obtain my full core limit for PM, and will be close to doing the same for AFL (only $500 away from 3K core position).

    So my strategy goes like this. Bring BP from $1,250 to $2,250 then switch to CVX and also bring that from current $1,250 to $2,250 as a full position. I am getting the total return as you discuss with BP but also the steady eddy with CVX.

    Just sharing my plans gets me excited. I cant wait until the 50 year old me thanks the 30 year old me for being forward looking and prudent.

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