Oil stocks have gotten a lot of attention in the past two years as the price of oil has fallen from $100 to $30 and has caused a lot of (hopefully unrealized) capital losses for investors in oil stocks and many of the dividends for oil stocks have come into question. There is a lot of historical data that suggests the long-term returns for oil stocks is excellent, and the returns become even more extraordinary if you are able to establish long-term positions in oil stocks at favorable valuations.
First, I’d like to direct your attention on some historical data points for oil stocks, which I am taking from page 53 of Jeremy Siegel’s classic work “Stocks For The Long Run.” In 1964, Standard Oil of NJ (now ExxonMobil) constituted 5.0% of the market cap of the S&P 500 and went on to deliver 13.82% annual returns for someone who held and reinvested through the end of 2015 For someone that bought Standard Oil of California (now Chevron), which was 1.4% of the S&P 500 in 1964, the long-run returns have been 13.23% annualized. Royal Dutch and Shell combined to form 2.0% of the index at the time, though they were separate entities, and have returned 12.82% annually through the present day since 1964. Standard Oil of Indiana, which constitutes 0.8% of the S&P 500 at the time, is now part of BP, and has delivered 10.80% annual returns since 1964.
Even if you didn’t invest in the largest oil stocks, an index of the sector still performed admirably over that time. An investor that purchased a market-cap weighted index of all oil stocks that were publicly traded on the New York Stock Exchange in 1964 would have compounded at 12.2% through the present day. You would have been right there with the performance of Exxon, Chevron, and Royal Dutch Shell, and you would have beaten BP (had you arrived at BP stock through the Standard Oil of Indiana–I am unsure of what your returns would have been if you were trading oil stocks on the London Stock Exchange at the time and came to BP that way).
What I find interesting about the historical performance of oil stocks is that your long-term return can be improved by a percentage point or two over the decades if you choose to buy the stocks during a period of low oil prices.The performance of these oil stocks includes the collapse of the late 1960s, early 1970s, the big one in the late 1980s, the mid 1990s, the short decline of 2008-2009, and the current sharp decline since July 2014 that has greatly reduced the price of nearly all oil stocks.
Among oil stocks that have existed since 1970, only Exxon and Chevron have not cut their dividend payments at all over that time frame. Both Exxon and Chevron have frozen their dividends since then, and have dividend growth streaks dating to 1981 and 1982. If there are only ten ideas you get from my writings that are not readily available elsewhere, I hope one of them is this: When oil stocks cut their dividends, it should not be treated as an opportunity to sell the stock.
If you purchased every oil stock on the New York Stock Exchange in 1986, a year in which there were many dividend cuts among oil stocks, you would have compounded your wealth at 11% through today (and nearly 13% annually through the summer of 2014). Historically speaking, you get paid a lot of money over the long haul to absorb the volatility of falling prices and dividend cuts in the oil stock sector.
It is the very definition of a well compensated risk: If you can be patient and maintain a clear head while others are freaking out, you will receive significant chunks of dividend growth and capital appreciation over the decades. The gains and falls come quickly, but in the aggregate, oil stocks trounce the S&P 500 Index over the long haul for this reason.
Even though reinvested dividends play a big role in the historical outperformance of oil stocks, this does not mean that a dividend cut negates the full effect of this benefit. If you own 1,000 shares of Conoco, you are not ruined by the 66% dividend cut that has seen the dividend come down from $0.73 quarterly to $0.25 quarterly. You still get $250 reinvested at $33 to give you 7.57 new shares. Those 7.57 new shares purchased at $33 will look very attractive twenty years from now when the price is much higher and each of those new shares gets to pay out their own dividends four times per year. The fact that cash is getting pummelled into the lower price of oil stocks is what counts, and there is still a very important long-term benefit being created in this moment even if the dividend payment is lower than what it once was.
I have little opinion on what the dividend future will be for BP and Royal Dutch Shell in the immediate sense–if oil stays at $30, these oil stocks can borrow money for a year or two to cover the payments if they decide. Or, they might want to free up capital and cut the dividend so that they don’t have to add any more leverage to the balance sheet. It’s within the range of reasonable discretion, as the numbers don’t clearly tell you what to do one way or the other. Exxon ought to continue hiking its dividend. Chevron is earning barely enough profit to cover either its dividend or capital projects, but not both–although the liquified natural gas projects in Australia come live within the next year and could make Chevron cash flow neutral even if the price of oil remains low.
In the past five years, it has become customary for people to think of stock market investments as things that appreciate nicely in a neat and tidy manner. That has never been how it works for the market as a whole historically, and it is certainly not how it works for oil stocks specifically. The best advice I have is that readers should study the history of oil stocks, and figure out what it is that drives returns. Frequent undervaluation, coupled with the reinvestment of some dividends into oil stocks, has been a key ingredient for explaining the historical outperformance of the sector.
This current trend of telling investors “sell when oil stock x cuts its dividend” is in no way historically supported by data. Oil stocks are obviously driven by the price of commodities, and the price of oil has historically changed in a hurry. You could easily see a quick run up to $60 or $70 per barrel of oil, and that would drastically change the short-term dividend expectations and share prices of the stock. Even though the long-term returns of oil stocks is somewhat predictable (you get between 10% and 13% returns depending on when you initiate the purchase), the short and medium term projections for oil stocks are very hard to predict. The academic studies of oil stocks overwhelmingly point us to the knowledge that low oil prices and dividend cuts are a signal of great buying opportunities for oil stocks, and some of the talking heads are doing your long-term net worth a great disservice by suggesting that you should get out now.
Sources Consulted: https://www.energy.vt.edu/vept/petroleum/crude_historical3.png
Jeremy Siegel. “Stocks for the Long Run.”
Originally posted 2016-02-15 18:08:23.